This paper provides a new argument for “shock” versus “gradualism” in the implementation of trade policies. In the simple context of a small open economy with rational expectations, we consider the comparative welfare effects of eliminating an import tariff either immediately as an unanticipated shock, or gradually over a preannounced length of time. The gradualist policy introduces a distortion in consumption-accumulation decisions and generates welfare costs. And if the gradual change is extended over “too long” a period, these costs may exceed the long-run benefits of liberalization.
The impact of fiscal policy has garnered considerably less attention in academic circles than that of monetary policy, according to Roberto Perotti, Professor of Economics at Columbia University. Speaking at an IMF Institute seminar on April 2, Perotti reviewed recent empirical studies and highlighted several key findings. He noted that the composition of fiscal adjustment—whether pursued primarily through taxes or expenditures—was often a critical determinant of the plan’s longevity and ultimate success. In particular, a reliance on expenditure cuts was more likely to sustain the adjustment effort and reduce the government’s budget deficit. He also pointed out that, contrary to conventional wisdom, fiscal tightening is not always recessionary. It can have strong positive effects on private investment—in part because of an often-overlooked transmission channel of fiscal policy: the labor market.
are due to Nigel Chalk, Saul Lizondo and Jeromin Zettelmeyer for their insightful suggestions. Any error or omission is the sole responsibility of the author 77 For a review of the U.S. experience in 1968 with the use of tax rates for counter-cyclical purposes see for example Okun (1971, 1975), Brandson (1973), and Springer (1977). For more recent empirical literature on the consumption effect of tax changes in the United States see Parker (1999). 78 Budnevich and Le Fort (1997) have discussed the potential benefits and shortcoming of such policy for Chile. -121
due to Nigel Chalk, Saul Lizondo and Jeromin Zettelmeyer for their insightful suggestions. Any error or omission is the sole responsibility of the author 77 For a review of the U.S. experience in 1968 with the use of tax rates for counter-cyclical purposes see for example Okun (1971, 1975), Brandson (1973), and Springer (1977). For more recent empirical literature on the consumption effect of tax changes in the United States see Parker (1999). 78 Budnevich and Le Fort (1997) have discussed the potential benefits and shortcoming of such policy for Chile. -121