Fiscal Policy and the Real Exchange Rate

February 1, 2012

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Format: Chicago

Santanu Chatterjee, and Azer Mursagulov. Fiscal Policy and the Real Exchange Rate, (USA: International Monetary Fund, 2012) accessed December 27, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Government spending on infrastructure has recently increased sharply in many emerging-market economies. This paper examines the mechanism through which public infrastructure spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral adjustment costs, we show that government spending generates a non-monotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-offs. The effect of government spending on the real exchange rate depends critically on (i) the composition of public spending, (ii) the underlying financing policy, (iii) the intensity of private capital in production, and (iv) the relative productivity of public infrastructure. In deriving these results, the model also identifies conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities, namely the intertemporal relationship between government spending, private consumption, and the real exchange rate.

Subject: Consumption, Expenditure, Foreign exchange, National accounts, Public investment and public-private partnerships (PPP), Public investment spending, Real exchange rates

Keywords: Adjustment cost, Balassa-Samuelson productivity effect, Consumption, Deviations from PPP, Dynamic adjustment, Exchange rate, Exchange rate dynamics, Fiscal policy, Global, Government spending, Government spending increase, Intersectoral adjustment costs, Investment subsidy, Public capital, Public investment, Public investment and public-private partnerships (PPP), Public investment spending, Real exchange rate, Real exchange rates, Sensitivity to financing policy, Shadow price, Shocks to variation, WP

Publication Details

Pages:

40
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2012/052
Stock No:

WPIEA2012052
ISBN:

9781463937133
ISSN:

1018-5941

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