Business Cycles and Fiscal Policy in an Open Economy

The role of demand management policy is considered in a two-sector open economy model with price-taking firms and imperfect competition in the labor market. Demand management policies are shown to affect the equilibrium distribution of prices and hence output in the case of both supply (productivity) and demand (preferences) shocks. As agents are risk-averse, there is a welfare case for pursuing an active stabilization policy, and the optimal fiscal policy as well as the possibility of implementing this via automatic budget rules are discussed