Fiscal Policy and the Theory of International Trade
Introduction and Summary
This article integrates key aspects of fiscal policy into the theory of international trade under classical assumptions in which purchasing power parity holds, fiscal policy is perfectly anticipated, and the basic choice affecting individuals, besides the holding of transactions balances, is between present and future goods. The analysis is conducted under the assumption of three alternative monetary rules accompanying a given fiscal policy: (1) fixed exchange rates with passive monetary adjustment; (2) flexible exchange rates with fixed money stocks; and (3) fixed exchange rates with active domestic credit policies designed to hold international reserves constant. It is shown that the effect of fiscal policy on interest rates and the exchange rate is determined less by the method by which government spending is financed than by the division of government spending among the present and future periods. It is shown that, under certain circumstances, derived in the paper, a country may be able to put the entire burden, and more, of domestic government spending on the rest of the world. Retaliation, however, could cancel this result; nevertheless, it is shown that, under certain circumstances, reflecting economic power, one country could gain by nationalistic fiscal policy even if the other country retaliated, provided it did so in an “optimum” way with no intention to damage the aggressive party. The assumption that the rest of the world is monolithic is then dropped, and the rest of the world is divided into partner and rival countries, leading to the important real-world result that some countries are always helped by a country’s fiscal policies, whereas other countries are hurt. In the final section the possibility of cycles in the age-profile of the population at home and abroad are taken into account and the effect on interest rates and trading patterns noted.
KeywordsExchange Rate Fiscal Policy Money Supply Government Spending Excess Demand
Unable to display preview. Download preview PDF.
- Barro, Robert ed. 1989. Modern Business Cycle Theory. Cambridge, Massachusetts: Harvard University Press.Google Scholar
- Barro, Robert. 1989. The Neo-Classical Approach to Fiscal Policy. In Barro, ed., 1989, Ch. 5.Google Scholar
- Fisher, Irving. 1930. The Theory of Interest. MacMillan: London.Google Scholar
- Modigliani, F. and R. Brumberg. 1955. “Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data.” In K. Kurihara, ed., Post-Keynesian Economics. London.Google Scholar
- Modigliani, Franco. 1986. “Life Cycle, Individual Thrift and the Wealth of Nations.” American Economic Review 76:3 (June): 297–313.Google Scholar
- Mundell, R.A. 1965. “Growth, Stability, and Inflationary Finance.” Journal of Political Economy 73: 79–109.Google Scholar
- Mundell, R.A. 1971. Monetary Theory: Inflation, Interest, and Growth in the World Economy. Pacific Palisades: Goodyear.Google Scholar
- Mundell, R.A. 1989a. “Trade Balance Patterns as Global General Equilibrium: The Seventeenth Approach to the Balance of Payments.” Rivista di Politica Economica 79 (6): 9ff.Google Scholar
- Mundell, R.A. 1989b. “The Global Adjustment System.” Rivista di Politica Economica 79 (12): 351–464.Google Scholar
- Mundell, R.A. 1990a. “Debts and Deficits in Alternative Models.” Rivista di Politica Economica 80 (7/8): 5–129.Google Scholar
- Mundell, R.A. 1990b. “The International Distribution of Saving: Past, Present and Future.” Rivista di Politica Economica 80 (10): 5–56.Google Scholar