Fiscal Policy, Capital Accumulation, and Debt in an Open Economy

This paper analyzes the effects of changes in government expenditures on both a domestically produced and an imported good in an open economy based on intertemporal optimizing behavior. The dynamic adjustment is characterized in detail and the critical role played by the accumulating capital stock is highlighted. The evolution of the current account is seen to mirror that of capital. The welfare of such policies is also assessed in tans of the intertemporal utility of the representative agent. Both permanent and temporary policy changes are considered, with the latter being shown to have a permanent effect on the economy.