Using Fiscal Policy to Target the Exchange Rate

8 Pages Posted: 21 Jul 2018 Last revised: 12 Oct 2018

See all articles by DeLisle Worrell

DeLisle Worrell

DeLisle Worrell and Associates, Inc.

Date Written: October 09, 2018

Abstract

This paper proposes an approach to macroeconomic policy which equips the authorities in small, open, financially-integrated economies (SOFIEs) to target the exchange rate by influencing the volumes of trade in goods and services to achieve equilibrium at the target rate. This is achieved by the use of fiscal policy: the authorities may adjust the size of the fiscal deficit and how it is financed to contain the level of aggregate expenditure in the economy, and the demand for imports that flows from that expenditure. In the longer term, productivity-enhancing measures will secure growth in the supply of foreign exchange. The exchange rate anchor keeps domestic inflation in line with world price changes. Moreover, the anchor is a powerful indicator of economic policy success and a persuasive reason to adopt necessary adjustment. A country which is able to set an exchange rate target and achieve it consistently over time gains credibility for its overall economic strategy. In the open economy the impact of depreciating exchange rates on the purchasing power of incomes is considerable, and erodes the savings habit. Exchange rate volatility discourages investment and may cause financial instability.

Keywords: macroeconomic policy, monetary policy, fiscal policy, exchange rate, open economy

JEL Classification: E17, E50, E61, F41, F43

Suggested Citation

Worrell, DeLisle, Using Fiscal Policy to Target the Exchange Rate (October 09, 2018). Available at SSRN: https://ssrn.com/abstract=3204921 or http://dx.doi.org/10.2139/ssrn.3204921

DeLisle Worrell (Contact Author)

DeLisle Worrell and Associates, Inc. ( email )

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Fisherpond
St. Jospeh BB21000
Barbados

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