The Effects of Openness on the Stabilizing Role of Fiscal Policy

Economic theory predicts that trade and financial openness reduce the fiscal multiplier. This paper tests these predictions using two panel data sets (1) from the period 1983-2011 for a sample of 72 developed and developing countries, and (2) from the period 1971-2011 for a sample of 51 developed and developing countries. The evidence shows that fiscal policy is indeed less effective for countries with greater trade or financial openness. The empirical estimates suggest that a 10% increase in trade openness reduces on average the long-run fiscal multiplier by 7-9%. Financial openness, on the other hand, has a less precise effect on the size of the fiscal multiplier.