Giovanni Ganelli, Juha Tervala
Dynamic Scoring in Open Economies
Volume 70 (2014) / Issue 1, pp. 31-66 (36)
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This paper fills a gap in the literature by focusing on the degree of self-financing of tax cuts in a New Keynesian two-country model. We find that the degree of self-financing of income tax cuts is negative on impact, but it quickly becomes positive. The open-economy dimension does not matter much for the long-run degree of self-financing. This is because the main channel through which the open-economy dimension affects the results – an expenditure-switching effect stemming from exchange-rate appreciation – is not active in the new steady state, in which the economy reaches a new flexible-price equilibrium.