Maria da Conceição Tavares and demand-led growth in developing countries

New paper by Franklin Serrano, Miguel Carvalho and Ricardo Summa on Maria da Conceição Tavares (1930-2024) and her contributions to demand-led growth theory. The paper reviews the pioneering contributions of Maria da Conceição Tavares to the theory of demand-led growth, emphasizing her early recognition that effective demand is central not only in the short run but also in the long-run process of capital accumulation. In that respect, it is more focused and detailed in the discussion of economic growth, than my paper (in this book) that tried to put her ideas in the context of the Latin American Structuralist School, and the emergence of heterodoxy in Brazil.

From the 1960s onward, Tavares developed a framework that departed from dominant development economics, which typically treated growth in developing countries as supply-constrained. Instead, she argued that developing economies function like any capitalist system, where output and growth respond to demand.

A key contribution highlighted in the paper is Tavares’s analysis of structural change during import substitution industrialization. She explains how growth regimes can shift from export-led to domestic demand-led as the economy develops a capital goods sector and increases the domestic content of demand. Public investment and industrial policy play a central role in sustaining this transition, reinforcing the idea that growth is driven by expanding demand rather than limited by supply constraints.

The paper also stresses her critique of stagnationist theories. Against views (including Celso Furtado’s work) that predicted long-run stagnation due to structural constraints, Tavares argued that slowdowns are typically the result of insufficient effective demand rather than inherent limits to growth. By distinguishing between capacity and its utilization, she shows that apparent structural problems often reflect cyclical demand deficiencies.

Another central element discussed in the paper is her Kaleckian inspired separation between distribution and accumulation. Tavares argued that income distribution does not mechanically determine growth. Instead, it affects demand conditions but does not impose a necessary trade-off between consumption and investment. Growth depends on autonomous components of demand, and different distributive regimes can sustain accumulation depending on the broader demand structure.

The paper emphasizes her original contribution regarding autonomous demand, particularly capitalist consumption and public expenditure. These components, along with residential investment, are seen as crucial drivers of long-run growth because they sustain demand without directly expanding productive capacity. This insight anticipates later developments in demand-led growth theory, especially the supermultiplier framework.

Finally, and perhaps more importantly, the authors discuss Tavares’s views on investment and financial capital. Drawing on Hilferding, Hobson and Schumpeterian ideas, she incorporates autonomous investment linked to innovation and financial structures. The paper concludes by showing her influence on two strands of contemporary research, one that treats investment as fundamentally autonomous, related to the financialization literature, particularly as developed at Unicamp, where Tavares taught starting in the 1970s, and another, associated to Serrano himself and his co-authors at Tavares's alma mater in Rio, that led to the Sraffian supermultiplier, where investment is entirely induced.

The bridge to austerity and stagnation

I have always emphasized in the blog the importance of  the Principle of Effective Demand and the pitfalls of Say’s Law, as central to understand Keynesian economics. Keynesianism is about that and NOT about the rigidity of wages, or the interest rate, or even fundamental uncertainty (something to which Keynes had to appeal to defend his ideas from 1937 on, as a result of retaining the marginalist notion of the marginal efficiency of capital). Very often that is an abstract discussion, hard to follow for students. I'm in the middle of teaching this again this semester (first time I taught Intermediate Macro was in 1993 at the Universidade Federal Fluminense, UFF).

A recent paper by Guilherme Haluska, Franklin Serrano, and Ricardo Summa (2026) provides a good empirical look at these theories in action. The authors analyze the period from 2015 to 2022 in Brazil, a phase marked by a radical shift toward fiscal austerity, labor reforms, and a rigid constitutional cap on government spending. This policy shift, famously dubbed "The Bridge to the Future," was predicated on the neoclassical belief that cutting public spending would boost confidence and reduce interest rates, thereby triggering an explosion of private investment and export-led growth.

The results, as the authors demonstrate, were exactly the opposite: the bridge led straight to stagnation. By utilizing a demand-led growth framework, they show that the sharp contraction in public investment and social spending actually dragged down aggregate demand. Far from being crowded in, private business investment fell as a share of GDP because firms, facing a shrinking domestic market and stagnant consumption, had no incentive to expand capacity. In other words, the accelerator works. As often emphasized in this blog.

The paper serves as a powerful contemporary reminder that, as Keynes argued and as we have noted in many prior posts (too many to link), when the state retreats from its role in managing demand, the market often fails to find a natural path back to prosperity, leaving the economy trapped in a low-growth equilibrium.

PS: A version of that, linked in the blog before, here. For a few similar posts suggesting Brazil has no fiscal problems, see this from 2024, or this one, this one from 2019, and this one from the beginning of the Brazilian stagnation period in 2015 (check how correct, in your view, my predictions were).

Recession, Stagnation, Inflation, Debt Crises and more (with Franklin Serrano, Ricardo Summa, and Nathalie Marins)

Slow at posting. This should have been uploaded before, but it wasn't on my Zoom account. At any rate, I think the panel holds well even after a couple of months (from late February).

Serrano, Summa and Marins on Inflation, and Monetary Policy

This is the full round table on Inflation and Monetary Policy organized by the Bucknell Institute for Public Policy (BIPP), with Franklin Serrano, Ricardo Summa and Nathalie Marins.

Cycles: empirics and the supermultiplier theory

 

New paper on the empirical evidence of the relevance of the supermultiplier for explaining economic cycles by Ricardo Summa, Gabriel Petrini, and Lucas Teixeira. From the abstract:

The demand-led supermultiplier growth model proposes that business investment is induced by income while autonomous expenditures determine economic growth. The most known versions of the model are presented at high levels of abstraction, focusing on general analytical properties and dynamic stability conditions. Based on those versions, Nikiforos et al. (2021) argue that the supermultiplier model cannot generate business cycles compatible with the empirical observation. In this paper, we show that this conclusion is a consequence of the misspecification of the variable chosen to represent the investment share, which includes business and residential investment. As the separation of those expenditures is a central point in the supermultiplier theory, we estimate a VAR model for the US economy (1967-2020) using only the data on business investment share instead. This procedure re-establishes an important feature to the supermultiplier theory, the mechanism of capital stock adjustment, as the empirical results points to the business investment share generally lagging the cycle. Finally, we make some remarks on how to discuss the business cycle from the supermultiplier perspective. We argue that for the supermultiplier, the business cycle depends less on the mechanism of capital stock adjustment than on the behavior of the autonomous components of demand and changes in the multiplier components. As the latter two are influenced by political, social and institutional factors, each business cycle has its own narrative.

Download here.

Di Bucchianico on Krugman and the Liquidity Trap

New paper on the problems of Krugman and the Liquidity Trap argument (some will be able to download if for free, and I recommend this version; however, there is a previous working paper linked at the bottom for those unable to open).

From the abstract:

Krugman’s ‘liquidity trap’ model constituted a ground-breaking contribution by attributing the long-lasting Japanese stagnation to a negative natural interest rate. Our critique to such a proposal will focus on three aspects. First, we will question the logical structure of the model, providing an alternative interpretation of its closure and arguing that aggregate demand has no crucial role in it. Second, we will argue that a negative natural interest rate can emerge only after a series of overtly restrictive assumptions in a model that does not treat capital and avoids long-run equilibrium analysis. Finally, we will discuss the mainstream literature which followed up until the recent rediscovery of the Secular Stagnation Theory. Within that line of literature, the key features of the ‘liquidity trap’ model continue to occupy a prominent role, thereby letting the critical issues that have been singled out resurface. Our conclusion is that the ‘liquidity trap’ explanation did not provide a satisfying rationale for Japan’s stagnation and cannot describe later economic predicaments either. A comparison with Post-Keynesian models shows their ability to offer insightful policy prescriptions without relying on those shaky theoretical foundations.

Note that an important part of the argument is the critique of the natural rate of interest, something we have done extensively over many years in this blog, and of the notion of a negative one in the context of Summers' discussion of secular stagnation (also done in this blog; see for example here and more recently here in the context of a debate with Stephanie Kelton and MMTers; btw her book is out and anybody wanting to reviewed it for ROKE send me an email; I look forward to reading it too).

The important thing in the paper is that it goes beyond the capital debates critique, and shows the extra restrictions needed for Krugman to get his results, including some interesting thoughts on the problems associated with intertemporal models.

PS: ROKE will soon publish a paper by Serrano, Summa and Garrido Moreira (Fall issue) in which other limitations of the negative natural rate are explored.

PS': Link to working paper here.

Who really wants the (Brazilian) economy to grow?

Franklin Serrano and Vivian Garrido (Guest bloggers)

When the Brazilian economy was growing with low unemployment rates and reducing income inequality, it was said that “businessmen have never made so much money” and, at the same time, the business community’s discontent with the government was increasing. On the other hand, in the current situation of semi-stagnation that followed from a deep recession, the entrepreneurs of both real and financial sectors declare their unrestricted support to the current government, despite the daily mess and shame of various government members and the bad economic conditions. We believe that, in order to understand both this apparent paradox and the very tendency of the Brazilian economy to stagnate, it is useful to clarify some basic theoretical relationships between investment, growth of demand and profitability.[1]

What matters to entrepreneurs?Entrepreneurs want "profitability". Profitability is not simply about selling more (total profit volume), but about the amount of profit compared to the size of the invested capital. Of course, as the economy grows, the volume or mass of profits invariably increases in absolute terms. But, as Garegnani said, companies do not care about the mass of absolute profits, but about the rate of profit, that is, the amount of profit relative to the capital invested; this variable may simply be called “profitability”. However, in the short run, the capital stock already installed is given; it’s a result of past investments. Then, in this short run, the rate of profit on this capital stock will depend only on the amount of profit and this, by its turn, depends on two factors: how much is produced and sold (the level of output) and the share of the product (and income) that goes to profits. Let us clarify in more detail these two factors.

In order to do so, let's imagine a scenario (let's call it “scenario 1”) in which real wages rise more than the trend of growth of labor productivity. This tends to reduce the rate of profits as the share of profits on sales (the second factor above) falls. It is true that, since in aggregate level these increases in wage share tend to increase the demand for consumption (because the share of wage income spent on consumption is naturally higher than that of profit income), aggregate consumption and production increase, which means that, in the short run, the degree of utilization of already installed capital increases and firms as a whole, partially offset lower margins with higher sales (i.e., the first factor above). Lower margins tend to decrease the rate of profit, but higher sales, on the other hand, tend to increase the rate of profit on this already installed capital stock. But one thing does not fully offset the other. This offset, however, besides being of a short term nature, is also only partial, as any increase in the payroll increases company costs and only part of this increase comes back as additional demand and revenue for them. This is because part of the amount of these additional wages will be spent directly on imported consumer goods (and indirectly on imported inputs of consumer goods produced in the country). Another part of the payroll increase goes either to pay direct taxes or is captured by indirect taxes paid by consumers and embedded in the price of retail goods. And also because part of the payroll is saved or used to pay workers's debts with the financial sector (whose owners tend not to spend these revenues).

So, is this profit rate that matters to entrepreneurs?Not really; or rather, although this is the actual rate of profits realized on the existing capital stock, it is not the rate of profit that determines the expected profitability of entrepreneurs in their new investments. In the latter case, companies are going to invest an adequate amount for the production capacity to adjust to the new expected total demand (which, in the present case, has grown) at a planned or normal degree of utilization, that, in its turn, is calculated to meet the expected fluctuations in demand, which implies that now (beyond the short term), the volume of capital invested will increase. Therefore, because of the rise on real wages, the expected rate of profit on new investments will fall as much as the share of profits will fall, without any partial compensation (as in the previous case), and gradually the profit rate related to the capital that is being installed goes falling as much as the expected rate of profit. And this rate of profit, that is, the rate of profit on the productive capacity planned to be used at the normal level, is the one that matters, because it determines the expected profitability. This longer run profit rate is called the “normal” or “expected” rate of profit.

But why do companies focus on the expected rather than on the actually realized profit rate?Well… due to competitive pressure, firms do not want either to overestimate the expansion of the market (in order to avoid loss), nor underestimate this expansion, otherwise they will lose market shares to rival companies and/or new entrants in their sectors. Hence, any individual entrepreneur who refuses to invest just because he is not content with a lower profitability (i.e., a lower normal rate of profit) while demand is expanding will simply be losing market share to another one. The idea of ​​planning the production capacity to be used at the so-called “normal” level contemplates the possibility of fully meeting the average demand over the life of the equipment while maintaining a slack to meet temporary or seasonal demand peaks, thus avoiding losing market share to competitors during these peaks. And because the productive capacity is planned to operate at the normal level based on the expected demand, then it is the expected not the realized rate of profits that becomes decisive.

Does this mean that, although “upset”, entrepreneurs still invest knowing that their expected profit rate will fall?

Exactly.

So, profitability matters to entrepreneurs but it doesn't matter to the investment decision? What do you mean?

This is where we would like to separate and clarify the confusion between the expected profit rate and the investment decision. The total amount of investment depends only on the expected demand and not on the expected profit rate! This leads us to two opposite but not antagonistic conclusions. First, that the business community generally does not like reductions in the share of profits in income through real wage increases above the rising trend in labor productivity. That is, as we said above, the business community struggle for their profitability, because this is what matters to them. But second, when this scenario of a rise in the wage share actually happens and markets expand, the combination between competition and the lack of a better alternative, cause entrepreneurs to expand their investments, even if expected and realized profit rates are falling, unless they fall below their opportunity cost, given by the interest rate, which is its lower bound. With profit rates still above this lower limit and if demand is expanding, investment continues to grow. A central implication of these propositions is that the reaction of the business community to a downward trend in profitability will not be, therefore, an implausible "investment strike." As Kalecki said: "capitalists do many things as a class, but they certainly do not invest as a class". If and when there is a capitalist reaction, it will consist of doing something like political pressure for the State to change the economic policy regime, in order to reverse the situation in the direction of their own interests.

To illustrate, let us now suppose a second scenario (let's call it “scenario 2”), where we observe such a class reaction that succeeds and, through austerity policies, the government manages to generate stagnation with mass unemployment and this then reverses the trend of rapid growth in real wages. In this second scenario, if demand is no longer expanding and even more if there is unwanted idle capacity in the already installed capital stock, companies have no incentive to invest, no matter how much real wages and other costs or taxes and corporate contributions fall, due to labor reforms or social security or due to tax exemptions to firms in general. As much as the business community can and will be satisfied with this high level of profitability, there is no incentive for additional investment, since it would only create unnecessary productive capacity. Probably some entrepreneurs will invest in innovations to steal market share from other companies. But if the innovators succeed, those other companies that have lost market tend to reduce their own investments in the same magnitude. Unfortunately, without growth of final demand, an aggregate expansion of investment will not be sustained for too long.

And what matters to workers?Naturally, workers generally are interested in more jobs, and in increase in real wages. Both factors are directly connected with higher economic growth because growth tends to generate more jobs. In fact, politically and historically, it is through decreasing unemployment and underemployment that the bargaining power of workers rises (and has risen) and facilitates the achievement of higher real wages and better working conditions. Increases in real wages above labour productivity growth is even better for workers, because, in this case, in addition to the initial increase in wage purchasing power, there is an increase in the economy’s aggregate marginal propensity to consume (share of total income that is spent on consumption) and thus, an additional increase in aggregate demand and employment as a result of this wage increase itself.

In our view, due to a number of structural characteristics of the economy, Brazil was, until 2010, close to the previous situation described above, which is equivalent to our scenario 1. These characteristics had included elements such as: the demographic transition _ reducing the growth of labor supply _ and the low labour productivity growth _ due to a more than proportional expansion of the services sector, what generated more employment than the expansion led by other sectors. In addition, several aspects of the growth pattern adopted, based on a strong rise in the minimum wage, an elevation of job formalization, and an expansion of the welfare state (giving the poor the opportunity to survive or study without working in precarious conditions) contributed to increase the bargaining power of workers, especially the low-skilled ones, which has grown substantially and unexpectedly during the boom of the Brazilian economy since 2004. Nevertheless, since 2011 the government, pressured by the discontentment of the capitalist class with this trend, has taken a number of palliative measures to restore the corporate profitability (especially tax exemptions) and seemed to have been surprised with the lack of positive impact of such measures on private investment, in a context where government had helped to decrease markedly the growth of demand. Then, in 2015, the government decided to assume the austerity policies and the gradual weakening of the welfare state with the reduction of social rights. The capitalist class and its external allies, counting also on the support of the workers with higher salaries (the latter particularly outraged by basic wages increase and progressive measures such as the 2013’s housekeepers PEC[2]) and seeing that they had nothing to fear from a government without any firmness, set out to attack. And, through a succession of coups, the transition to something close to our scenario 2, against the workers' interests,was completed, and here we are now. Profitability conditions improve by each measure taken by the government, helped by the low bargaining power of the workers in this stagnant and mass unemployment economic situation.

In short ...

… With this note, we came up with a scenario that now, we hope, seems less paradoxical, and it is: a) interesting for entrepreneurs; b) uninteresting for workers; c) with an upward trend in the profit rate and d) with low investment growth.

Due to the weak growth of demand that largely resulted from austerity policies, investment and the economy are barely growing and there is a huge and successful effort to focus the political debate on anything but the state of the economy and social rights, in order to prevent the loss of legitimacy and maybe electoral failure of forces supporting the government. Promoting economic growth is not and has never been a priority for big businessmen and, as has been clearly acknowledge, neither growth is a government priority. But who really needs growth are not the entrepreneurs in general _ apart from some small entrepreneurs, for whom and whose family the company generates jobs _ but the workers.

REFERENCES

SERRANO, F. & SUMMA, R. F. (2018) Conflito distributivo e o fim da “breve era de ouro” da economia brasileira. Novos Estudos CEBRAP, v. 37, p. 175.

NOTES:

[1] For more details see Serrano and Summa (2018)

[2] PEC is a brazilian instrument created to facilitate changes in small parts of the Federal Constitution. In the case refered in the text, it was a particular formalization of housekeeper’s jobs.

Distribution and Conflict Inflation in Brazil under Inflation Targeting

I can't watch this either

For those interested in the Brazilian situation I highly recommend the recently published paper by Franklin Serrano and Ricardo Summa (Review of Radical Political Economics page here). From the abstract:

In this paper, we analyze Brazilian inflation under the inflation-targeting system from a conflict inflation perspective and show how the inflation target system only worked well when there was a trend of exchange rate appreciation. Later, the strengthening of the bargaining power of workers and rising real wages since 2006, combined with continuous nominal exchange rate depreciation after mid-2011, increased distributive conflicts and are ultimately behind the recent shift toward austerity.

 A preliminary version is available here.

Brazil's Economic Slowdown Results from Policy Decisions

A new research paper from the Center for Economic and Policy Research examines the causes of Brazil’s recent economic slowdown and finds that policy choices rather than external factors have been the most important cause. The paper shows that the sharp slowdown that Brazil has experienced since 2011 is overwhelmingly the result of a significant decline in domestic demand that resulted from policy choices made by the government. It concludes that this decision to slow the economy was not necessary as there was no external constraint, such as a balance-of-payments problem, that warranted it.

“There have been enormous economic and social gains since the Workers' Party took office in 2003, in terms of reducing poverty (by 55 percent) and extreme poverty (by 65 percent), increasing employment, income growth, and some reduction in inequality,” CEPR Co-Director Mark Weisbrot said. “However, these gains are being eroded and are seriously threatened if the government continues on its current path.”

The paper, “Aggregate Demand and the Slowdown of Brazilian Economic Growth from 2011-2014,” by CEPR Senior Research Associate Franklin Serrano and economist Ricardo Summa, looks in detail at the sharp slowdown in the Brazilian economy for the years 2011-2014, in which economic growth averaged only 2.1 percent annually, as compared with 4.4 percent in the 2004-2010 period. The authors argue that the slowdown overwhelmingly results from a sharp decline in domestic demand led by government policy, rather than from a fall in exports or from any change in external financial conditions.

Read rest here.

Mundell-Fleming, Independent Central Banks, Inflation and Openness

Bucknell's Academic West (Bertrand Library in the background)

Teaching international finance this semester, after a long while. At Utah I taught mostly intermediate macro and Latin American Development for undergrads (and macro and history of thought for graduate students), and the eventual elective. But here the course was up for grabs, so to speak. Decided to use Peter Montiel's International Macroeconomics, since his books always provide competent presentations of the mainstream views, plus having worked at the IMF and World Bank, he always tries to cover real problems with plenty of developing country examples.

The limitation of the book is, as it should be expected, that the mainstream analytical view is, as Montiel's (p. x) says: "a generalized and modernized [sic] version of the original Mundell-Fleming model." The book does present in the last chapter the 'modern' intertemporal approach to the current account. In a later post I'll discuss the limitations of the Mundell-Fleming model, but for those interested check this paper by Serrano and Summa. In other words, Montiel's book can present the mainstream views, but lacks any critical perspective, which is not uncommon, but certainly problematic given the poor state of the mainstream understanding of how the economy works.

It is illustrative of the lack of alternatives in the book, the presentation of the relation between openness and inflation. Montiel's follows the evidence on an inverse relation between openness (that can be measured in many ways: import share, imports plus exports over GDP, etc.) and inflation presented in David Romer's well-known paper (see here). Montiel argues that in closed economies governments might tend to run fiscal deficits, that if monetized, would lead to inflation. In a more open economy, the higher deficits and inflation would lead to higher rates of interest, since international creditors faced with a risky government would demand a higher premium. In this context, "the higher interest rates that the government has to pay would tend to discourage excessively expansionary fiscal policies, thus reducing pressures on central banks to expand the money supply." If the central bank is more autonomous or independent from the Treasury then you should expect also less inflation (that would be Bernanke's explanation for the Great Moderation; here).

Many problems, as you can see. Yes, for Montiel inflation is caused by excess demand (fiscal deficits) and by increasing money supply, which seems to be what the central bank controls (let alone that all central banks control really the rate of interest). Worse, in a sense, is the notion that fiscal deficits in domestic currency (presumably, since nothing is said), may cause foreign investors to punish the government. Note that what should have investors concerned would be the current account surplus (which provides foreign reserves) and the amount of foreign reserves held by the central bank. The evidence on interest rates and fiscal deficits, by the way, is less than forthcoming for Montiel's story (see here).

A simple alternative suggests that inflation more often than not is caused by cost pressures, rather than excess demand, and that two of the main sources of cost pressures are the prices of imported goods and wage pressures. In a more open economy, in which firms are faced with competition from foreign firms, and workers might be afraid of losing their jobs, then wage resistance might be subdued. Note that over the last few decades unionization rates have declined and that also constrains the ability of workers to demand higher wages (see here). In this case, lower inflation in the globalized economy has been predicated on a weaker labor force that faces more international competition, and is more willing to accept stagnant wages. Inequality and stagnant wages, rather then well-behaved governments and independent central banks are behind the Great Moderation in this story.

Two ex-graduate students of mine, Perry and Cline (yes, someone was paying attention after all), teamed up and provided some empirical evidence in favor of the alternative story (go here). If you want to see alternative views on inflation, implicit in this discussion, go to the linked posts and papers here.

The IMF and stylized fiction

The IMF has posted their Top 20 list of most popular entries since the launch of the blog. At #3 they have the Ten Commandments of Fiscal Adjustement in Advanced Economies, which is from 2010, but still worth reading, since their views have hardly changed. I am not going to go through the whole list, even though it does merit careful analysis. I want just to point out a few problems with three of the commandments (do they really need the religious analogy?). This 10 Commandments are based on the IMF's views on the stylized facts of fiscal consolidations.

Note that the IMF wants a reduction in debt-to-GDP ratios in the long run (commandment #3), even if nobody knows exactly what is the difference of having a 40% ratio, which they recommend for 'emerging markets' (meaning developing economies), or a 250%, as the UK had during the Napoleonic Wars (here). My first concern is with the idea that consolidation (by which they mean austerity) should be done by cutting spending and not increasing taxes (#4), because this is more conducive to growth.

This is a proposition they repeat in their last Fiscal Monitor (2012: p. 35), where we are told that:

"a number of earlier studies have shown that expenditure-based fiscal consolidations have a more favorable effect on output than revenue-based consolidations, in spite of the standard multiplier analysis … Chapter 3 of the October 2010 World Economic Outlook reaches the same conclusion (IMF, 2010b) and notes that this result is partly because, on average, central banks lower interest rates more in the case of expenditure-based consolidations (perhaps because they regard them as more long-lasting)."

Note, however, that the reason for the superior performance for cutting spending instead of raising taxes (on the rich one would hope) is that the Central Bank does not hike rates in the former case, since it is part of a conservative plan to reduce the size of government (note that the IMF asks for consolidations to be fair, #6, but then wants to cuts social spending, #5). Worse the notion is also based on the idea that lower (higher) spending brings down (up) the rate of interest and leads to crowding in (out) of private investment. The problem is that the evidence for a positive (negative) effect of fiscal deficits (surplus), or public spending increase (reduction), on interest rates, is that it is almost non-existent (see UNCTAD, 2011, chapter 3 for a review).

The other point is related to the last commandment (#10), which says that you should coordinate your macroeconomic policies with other countries. I'm not even going to deal with the problems of coordination. My problem is that the arguments tend to be based on the Mundell-Fleming (MF) model (the ISLMBP with perfect capital mobility), which suggests that fiscal policy is less efficient in a small open economy. In this case, fiscal policy raises the rate of interest, with capital mobility, pressures for inflows lead to an appreciation of the currency, and lower trade surpluses. Instead of crowding out, meaning lower investment, one gets lower output from the external accounts. That's why they say in their last Fiscal Monitor that "in line with the theory, fiscal multipliers tend to be smaller in more open economies" (2012, p. 33).

Again this depends on a weak empirical relation. In the United States seldom is the case that expansionary fiscal policy causes higher rates of interest. In fact, the policy of the strong dollar, with the impact on manufacturing output and exports, has often been detached from fiscal expansionism or higher rates of interest (e.g. the Clinton years in which a strong dollar went hand in hand with fiscal consolidation and monetary easing to feed the dot-com bubble).

Finally, note that even small open economies in several periods were able to have very effective fiscal policies, because in spite of relatively flexible exchange rates, they used capital controls to avoid the effects of volatile capital flows on their external accounts. In this sense, the world of relatively regulated capital flows, rather than of fixed exchange rates (even if sometimes the two are confounded as a result of the Bretton Woods arrangement), seems to be more conducive to effective fiscal policy. So the lesson should not be that small open economies cannot do effective fiscal policy, but that capital controls (which they are not quite okay with contrary to what you might have heard, but I leave for another post) are necessary.

PS: For a more consistent theoretical critique of the MF model see Serrano and Summa (2012).