Agriculture Reference
In-Depth Information
Fixed exchange rate and fixed tax rates; there are no capital
controls.
Fixed tax rates, monetary policy targets the CPI, the exchange rate
floats and capital controls are removed.
Rigid capital controls and a fixed exchange rate; the direct tax rate
adjusts to maintain the government deficit as a fixed proportion of
GDP.
The closure is the same as number four, however, capital controls
are removed.
The short-run effects of the trade reform vary consderably under the
dfferent macroeconomc regmes. When captal controls are n place and
the exchange rate is fixed, the allocative gains from the tariff reductions
are insufficient to offset the contractionary effects of the deflation that is
due to the rse n the relatve prces of foregn goods. When captal controls
are weak, the trade liberalisation attracts increased inflows on the capital
account and mtgates the real deprecaton and assocated domestc prce
deflation. The real volume of investment rises irrespective of the target
of monetary policy, as does the level of GDP. The choice of monetary
policy still matters, however, with CPI targeting leading to a smaller GDP
price deflation, more modest gains in the real production wage and better
short-run GDP gans.
As with monetary policy, the impact of the different fiscal policies
depends on the strength of capital controls. Given tight capital controls,
if tax rates are held constant and the fiscal deficit expands, domestic
nterest rates rse and prvate nvestment s crowded out. Where ncome
tax increases to compensate for the tariff cut, there is less pressure on
the domestic capital market and the interest rate increase is less, as is
the fall in investment. In the absence of effective capital controls, the
case of no ncrease n the tax rates performs better than the alternatve
polcy. The ncreased government borrowng draws n nternatonal savngs
at nternatonal nterest rates and does not crowd out prvate nvestment.
Both fiscal policies, however, give superior results in the absence of capital
controls.
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