Optimal Fiscal Policy in a Small Open Economy with Incomplete Markets and Interest Rate Shocks

Purpose This paper aims to estimate a New Keynesian small open economy dynamic stochastic general equilibrium (DSGE) model for Egypt using Bayesian techniques and data for the period FY2004/2005:Q1-FY2015/2016:Q4 to assess monetary and fiscal policy interactions and their impact on economic stabilization. Outcomes of monetary and fiscal authority commitment to policy instruments, interest rate, government spending and taxes, are evaluated using Taylor-type and optimal simple rules. Design/methodology/approach The study extends the stylized micro-founded small open economy New Keynesian DSGE model, proposed by Lubik and Schorfheide (2007), by explicitly introducing fiscal policy behavior into the model (Fragetta and Kirsanova, 2010 and Çebi, 2011). The model is calibrated using quarterly data for Egypt on key macroeconomic variables during FY2004/2005:Q1-FY2015/2016:Q4; and Bayesian methods are used in estimation. Findings The results show that monetary and fiscal policy instruments in Egypt contribute to economic stability through their effects on inflation, output and debt stock. The monetary policy Taylor rule estimates reveal that the Central Bank of Egypt (CBE) attaches significant importance to anti-inflationary policy and (to a lesser extent) to output targeting but responds weakly to nominal exchange rate variations. CBE decisions are significantly influenced by interest rate smoothing. Egyptian fiscal policy has an important role in output and government debt stabilization. Additionally, the fiscal authority chooses pro-cyclical government spending and counter-cyclical tax policies for output stabilization. Again, past values of the fiscal instruments are influential in the evolution of the future fiscal policy-making process. Originality/value A few studies have examined the interaction between monetary and fiscal policy in Egypt within a unified framework. The presented paper integrates the monetary and fiscal policy analysis within a unified dynamic general equilibrium open economy rational expectations framework. Without such a framework, it would not be easy to jointly analyze monetary and fiscal transmission mechanisms for output, inflation and debt. Also, it would be neither possible to contrast the outcome of monetary and fiscal authorities commitment to a simple Taylor instrument rule vis-à-vis optimal policy outcomes nor to assess the behavior of monetary and fiscal agents in macroeconomic stability in context of an active/passive policy decisions framework.

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Government Debt, the Real Interest Rate and External Balance in an Endogenous Growth Model of a Small Open Economy

SSRN Electronic Journal ◽

10.2139/ssrn.2360281 ◽

2013 ◽

Cited By ~ 1

Author(s):

George Alogoskoufis

Keyword(s):

Interest Rate ◽

Endogenous Growth ◽

Growth Model ◽

Open Economy ◽

Real Interest Rate ◽

Small Open Economy ◽

Government Debt ◽

The Real ◽

External Balance ◽

Endogenous Growth Model

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HABIT FORMATION AND GOVERNMENT SPENDING IN A SMALL OPEN ECONOMY

Macroeconomic Dynamics ◽

10.1017/s1365100502020059 ◽

2003 ◽

Vol 7 (3) ◽

pp. 407-423 ◽

Cited By ~ 6

Author(s):

Cem Karayalçin

Keyword(s):

Fiscal Policy ◽

General Equilibrium ◽

Current Account ◽

Open Economy ◽

Equilibrium Model ◽

Government Spending ◽

Time Preference ◽

Small Open Economy ◽

Long Run ◽

Fiscal Shocks

The paper studies the effects of an expansionary fiscal policy in a general equilibrium model of a small open economy. Households are assumed to possess habit-forming, endogenous rates of time preference. In response to fiscal shocks, the model generates cyclical endogenous persistence and procyclical time paths for consumption, employment, and investment, as well as a countercyclical path for the current account. Furthermore, fiscal shocks are shown to have positive long-run effects on output and negative long-run effects on consumption.

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Interest Rate–Economic Growth Nexus Under Currency Board Operations

Journal of Empirical Studies ◽

10.18488/journal.66.2021.81.13.24 ◽

2021 ◽

Vol 8 (1) ◽

pp. 13-24

Author(s):

Martinianus Tshimologo Tibinyane ◽

Teresia Kaulihowa

Keyword(s):

Economic Growth ◽

Interest Rate ◽

Impulse Response ◽

Response Function ◽

Open Economy ◽

Small Open Economy ◽

Impulse Response Function ◽

Policy Instrument ◽

Variance Decomposition ◽

Currency Board

This paper analyses the effect of the prime interest rate as a monetary policy instrument to stimulate economic growth in Namibia, a small open economy that is constrained by currency board operations. A Vector Autoregressive Model (VAR) was used for the period 1980–2019. The result shows that Namibia’s prime interest rate has no significant effect on economic growth. This finding remains robust and consistent when impulse response function and variance decomposition are employed. The impulse response function indicates a shock on the prime interest rate exhibits an inverse relationship. However, this effect is insignificant in both short and long-run scenarios. The variance decomposition indicates that the prime interest rate has a strongly exogenous impact, implying it has a weak influence on GDP growth. Policy implication indicates that small open economies under currency board operations need to identify different policy responses to circumvent external shocks and addresses their development needs.

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