The role of fiscal policy in the determination of exports and imports: An empirical study of small open economies with fixed exchange rates

This study examines the impact of government spending and taxes on exports and imports for small open economies with fixed exchange rates. I develop a theoretical model to assess the impact of fiscal policy on the external accounts under different assumptions concerning Ricardian equivalence, the degree of substitution between private and public spending, and the degree of international capital mobility. The analysis of this model allows me to differentiate between sustainable fiscal policies and fiscal policies that will lead to the break-down of the fixed exchange rate rule.;The theoretical analysis is complemented by an empirical study of four small open economies with fixed exchange rates--Austria, Finland, Norway, and Sweden--for the period 1960-1990. I construct an econometric model and estimate both its structural and reduced form for the four countries individually, and for the pooled data. The estimations of the reduced form equations for imports, exports, and the current account show that the impact of government spending and taxes on imports is weak for all four countries. These reduced form estimates also reveal a significant relationship between fiscal policy and exports for Austria and Norway. However, the analysis of the structural equations of the model suggests that changes in exports cause changes in the fiscal variables rather than fiscal policy influencing exports.;The structural estimates also show that the governments propensity to import is much lower than that of the private sector. Country specific factors seem to be important with respect to the validity of the Ricardian equivalence hypothesis. The estimations of the structural equations for private expenditure, the rate of inflation, and the real rate of interest indicate only few deviations from Ricardian equivalence for Austria, Norway, and Sweden. For Finland, fiscal finance seems to exert non-negligible effects on the economy.