Productive Government Purchases and the Real Exchange Rate
8 Pages Posted: 29 Dec 2009
Date Written: December 8, 2009
Empirical research documents that an exogenous rise in government purchases in a given country triggers a depreciation of its real exchange rate. This raises an important puzzle, as standard macro theories predict an appreciation of the real exchange rate. We argue that this prediction reflects the assumption that government purchases are unproductive. Using a simple model, we show that the real exchange rate may depreciate in response to a rise in government purchases, if those purchases increase domestic private sector productivity. A very small dose of public sector externality is sufficient to generate this result.
Keywords: productive government purchases, real exchange rate
JEL Classification: F41, F42, E62
Suggested Citation: Suggested Citation