INCOME DISTRIBUTION AND ECONOMIC CYCLES IN AN OPEN ECONOMY SUPERMULTIPLIER MODEL

DVOSKIN ARIEL; TORCHINSKY MATÍAS

Documentos de Trabajo del BCRA

Banco Central de la República Argentina

Lugar: Ciudad Autónoma de Buenos Aires; Año: 2022 p. 1 - 35

Supermultiplier growth models show that higher autonomous spending leads tostronger economic growth, implying that greater government spending can boosteconomic activity (Freitas and Serrano, 2015). However, several authors highlightedthe limits of this strategy, arguing that increased spending might lead to unsustainabledebt accumulation patterns. This is particularly important for small open economies,where growth requires imports that must be paid with foreign currency, which can leadto growing external indebtedness (Thirlwall, 1979; Nikiforos, 2018; Oreiro and CostaSantos, 2019).We build a structuralist supermultiplier model for a small open economy with twosources of autonomous demand, government expenditures and exports. We account forthe dynamics of external indebtedness (determined by economic activity), wage growth(related to wage resistance) and the exchange rate (determined by the Central Bank butlimited by international reserves constraints). We find that, in the long run, there is alimit for government spending: its growth rate cannot exceed that of exports withoutgenerating an external crisis. However, there is a strong role for public policy: there isnothing that automatically leads the economy to its maximum growth rate compatiblewith the external constraint to growth, and if government expenditures grow less thanexports, the economy will not completely exploit its external space.But the main contribution of the paper is in the short-run analysis, where we find anadditional restriction, related to income distribution. Since higher wages increaseconsumption and economic activity, they also require more imports, potentially leadingto unsustainable debt growth. Therefore, there is a maximum real wage compatiblewith external equilibrium (Canitrot, 1983). If unions’ demand wages are lower than theexternal equilibrium wage, the economy will be stable, but will also achieveunnecessarily low output and real wages. On the contrary, if target wages exceed thosecompatible with external equilibrium, the economy displays economic cycles betweencapacity utilisation, income distribution and indebtedness, marked by permanentinflation. We show that, in the short run, the government can optimize fiscal andmonetary policies to maximise output given the external space, but that in the long run,economic growth requires not only domestic spending but also increasing exports to besustainable