The Composition of Government Spending and the Real Exchange Rate
23 Pages Posted: 20 Aug 2008
Date Written: July 2008
We show that the composition of government spending influences the long-run behaviour of the real exchange rate. We develop a two-sector small open economy model in which an increase in government consumption is associated with real appreciation, while an increase in government investment may generate real depreciation. Our empirical work confirms that government consumption and government investment have differential effects on the real exchange rate and the relative price of nontradables.
Keywords: government consumption, government investment, real exchange rate
JEL Classification: E62, F31, F41
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