OPTIMAL FISCAL-POLICY IN OPEN ECONOMIES WITH LABOR-MARKET DISTORTIONS

We set up a general equilibrium model with unemployment owing to disto rtions in the labour market. It is shown that a public expansion, fina nced by a distortionary income tax, may give rise to a decrease in une mployment. Even if public goods are pure waste, such an expansion may give rise to an increase in welfare if it is associated with a decreas e in unemployment. Since part of the gain from a fiscal expansion is a chieved at the expense of welfare in other countries, non-cooperative policies tend to be too expansionary.