Real wage rigidity and anticipated fiscal policy

Examines the implications of real wage rigidity for anticipated fiscal policy in the context of a small open economy operating a floating exchange rate. Employs an extended version of a Mundell-Fleming model, containing an explicit treatment of the supply side, in which domestic output depends on the real exchange rate through the latter’s influence on domestic production costs. Shows that in an economy characterized by real wage rigidity, the anticipation of a future fiscal expansion has an unambiguously expansionary effect. This result is in sharp contrast to the case in which nominal rigidities are present, where such a policy has an initial contractionary impact.