Productive Government Purchases and the Real Exchange Rate

9 Pages Posted: 20 Jun 2013

See all articles by Parantap Basu

Parantap Basu

Durham University - Department of Economics and Finance

Robert Kollmann

ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: July 2013

Abstract

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 might reflect the conventional assumption that government purchases are unproductive. Using a simple frictionless model with efficient international risk sharing, we show that the real exchange can depreciate in response to a rise in government purchases, if these purchases increase domestic private sector productivity, and labor supply is highly elastic. Empirically plausible marginal products of government purchases are sufficient to generate this result.

Suggested Citation

Basu, Parantap and Kollmann, Robert, Productive Government Purchases and the Real Exchange Rate (July 2013). The Manchester School, Vol. 81, Issue 4, pp. 461-469, 2013, Available at SSRN: https://ssrn.com/abstract=2282322 or http://dx.doi.org/10.1111/j.1467-9957.2012.02295.x

Parantap Basu (Contact Author)

Durham University - Department of Economics and Finance ( email )

Durham, DH1 3HY
United Kingdom

Robert Kollmann

ECARES, Université Libre de Bruxelles ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium

University of Paris XII - Department of Economics ( email )

61 avenue du General de Gaulle
Creteil cedex, 94010
France

HOME PAGE: http://www.robertkollmann.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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