Dynamic effects of government policies in a small open developing economy with external debt and sovereign risk

This dissertation evaluates the dynamic eects of government policies in a small open developing economy with external debt and sovereign risk. It is divided into three distinct chapters. Chapters 1 and 2 have a theoretical focus; they involve the developing of intertemporal optimizing models of a small open economy. In these chapters, we use the representative-agent framework to derive dynamic macroeconomic eects of dierent policy changes. Specically, chapter 1 examines the eects of an investment tax credit or investment subsidy (ITC) in a small open economy with an external borrowing constraint. It is shown that an increase in the rate of the ITC leads to an increase in the stock of foreign debt, consumption, capital accumulation, and output in the long run. Moreover, our results show that the accumulation of foreign debt exhibits non-monotonic adjustment. Particularly, an increase in the ITC leads to a current account decit followed by a surplus.Along with this non-monotonicity, our model also explains the positive correlation between savings and investment during the transitional periods. In chapter 2 we examine the eects of monetary policy in a small open developing economy with cash-in-advance (CIA) constraint, which borrows from an imperfect capital market. Monetary policy involves targeting the ination rate. Here, it is shown that an increase in the ination rate leads to a decrease in the stock of foreign debt. It also leads to a decrease in consumption, employment, capital accumulation, and output in the long run. Chapter 3 has an empirical focus. In this chapter, we use the sign restrictions methodology proposed by Uhlig (2005) to identify ination shocks and analyze their eects on consumption, investment and foreign debt for six developing countries. The identication procedure imposes sign restrictions on the impulse responses of consumption and investment to an ination shock.No restriction is imposed on the response of external debt. The main ndings are that, overall, an ination shock leads to declines in consumption, investment and the stock of foreign debt.