The Effects of Fiscal Shocks on the Exchange Rate in the EMU and Differences with the US
35 Pages Posted: 2 Jul 2012
Date Written: July 2, 2012
Abstract
We analyse the impact of government spending shocks on the real effective exchange rate and net exports in the Euro Area within a standard structural VAR framework. We employ a new database that contains quarterly fiscal variables for the Euro Area as a whole. We show that higher government spending leads to real exchange rate appreciation and to a fall in net exports, jointly with lower primary budgetary surpluses, which turns out to be fully consistent with the “twin deficits” hypothesis. The different components of public spending, namely wage and non-wage consumption expenditure, overall public consumption expenditure and public investment, bring about real appreciations. Our results are therefore also consistent both with the home-bias hypothesis of public expenditure and with public investment contributing to generating relative productivity gains in the traded goods sector.
Contrary to what is observed in the Euro Area, the real effective exchange rate depreciates in the US in response to higher government spending. This discrepancy can ultimately be explained by the reaction of nominal interest rate spreads and the uncovered interest parity condition. The dissimilar reaction of short-term nominal interest rate spreads is attributed to two factors, namely the role of the US dollar as a "safe haven" currency and the countercyclical behaviour of discretionary government spending in the US.
Keywords: Euro Area, SVAR, fiscal shocks, effective exchange rates, relative prices, twin deficits, fiscal multipliers
JEL Classification: E62, H30
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Costly Capital Reallocation and the Effects of Government Spending
-
What are the Effects of Fiscal Policy Shocks?
By Harald Uhlig and Andrew Mountford
-
What are the Effects of Fiscal Policy Shocks?
By Andrew Mountford and Harald Uhlig
-
What are the Effects of Fiscal Policy Shocks?
By Andrew Mountford and Harald Uhlig
-
Understanding the Effects of Government Spending on Consumption
By Jordi Galí, David Lopez-salido, ...
-
Understanding the Effects of Government Spending on Consumption
By Jordi Galí, David Lopez-salido, ...