Dynamics of Devaluation and "Equivalent" Fiscal Policies for a Small Open Economy

In pursuing a steady-state reserve target, policymakers in small open economies can resort to devaluation or to temporary increases in public saving. This paper contrasts the dynamic implications of these alternative policies in a model with optimizing agents who possess perfect foresight. In general, the private sector cannot be insulated from the effects of the government`s reserve-accumulation policies. The dynamic effects of devaluation depend on the fiscal policy rule in effect. In contrast to devaluation, the quot;equivalentquot; fiscal policies imply discontinuities in private consumption and temporary tax increases may cause key macroeconomic variables to overshoot their steady-state values