Balanced-budget consumption taxes and aggregate stability in a small open economy

- We study the indeterminacy issue under the balanced-budget consumption taxation in a small open economy.
- We show that for a small open economy facing a perfect world capital market indeterminacy cannot occur.
- This result is in contrast to those obtained in some recent closed economy models.
- The paper demonstrates that unfettered world capital mobility can help stabilize the economy.

In a small open economy facing a perfect world capital market, this paper shows that if the government follows a balanced-budget fiscal policy based on endogenous consumption tax rates, then the steady state is saddle-path stable and hence beliefs-driven aggregate instability can be ruled out. This result is in contrast to those obtained in some closed economy models, and it suggests that unrestricted world capital mobility can help stabilize the economy under the balanced-budget fiscal policy based on consumption taxation.