Implications of the Slowdown in Trend Growth for Fiscal Policy in a Small Open Economy

We set up and estimate a small open economy model with fiscal policy in which trend growth can permanently change. The magnitude and timing of the change in trend growth are estimated alongside the structural and fiscal policy rule parameters. Around 2003:Q3, trend growth in per capita output is estimated to have fallen from just over 2 per cent to 0.6 per cent annually. The slowdown brings about a lasting transition which in the short-run decreases consumption tax revenues but increases them in the long-run changing permanently the composition of tax revenues and temporarily increasing the government debt-to-output ratio