Abstract
Abstract The relationship between the size of government, economic growth, and volatility in a small open economy is analyzed. First, we characterize the stochastic equilibrium for a centrally planned economy, contrasting it with a closed economy. The role of government consumption expenditure both as a stabilizing and a destabilizing factor is discussed. The optimal size of government is derived and we find that an open economy will have a larger government if and only if it is a net creditor. Second, the stochastic equilibrium in a decentralized economy is characterized and the optimal tax structure derived. Finally, the role of government production expenditure and its impact on risk is briefly discussed.
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