Government Spending Effects in a Small Open Economy∗

In this paper, the government consumption spending effects in a small open economy(SOE), are explored. In a standard active monetary/passive fiscal policy(AM/PF) regime, openness reduces the effectiveness of the government spending on output through the terms of trade decrease. Consumption decreases less than in the closed economy, but this effect is so weak that the output does not rise more than that of the closed economy. In a passive monetary/active fiscal policy(PM/AF) regime, openness induces little change on output. With the existence of the terms of trade, openness causes less decrease in the primary surplus(by revaluating the government spending in CPI terms). Households feel wealthier than in the closed economy. This effect is compensated by the negative effects of the terms of trade(decrease) on output. In the standard AM/PF regime, an increase in the government spending does not increae output and inflation more, compared with the closed economy. In contrast, in the PM/AF regime, the difference between open and closed economies are small in terms of output and inflation.