The Worst of Both Worlds: Fiscal Policy and Fixed Exchange Rates

50 Pages Posted: 27 Nov 2019

See all articles by Benjamin Born

Benjamin Born

Frankfurt School of Finance & Management

Francesco D'Ascanio

University of Tuebingen

Gernot J. Müller

University of Tuebingen - Department of Economics

Johannes Pfeifer

University of Cologne

Multiple version iconThere are 2 versions of this paper

Date Written: 2019

Abstract

Under fixed exchange rates, fiscal policy is an effective tool. According to classical views because it impacts the real exchange rate, according to Keynesian views because it impacts output. Both views have merit because the effects of government spending are asymmetric. A spending cut lowers output but does not alter the real exchange rate. A spending increase appreciates the exchange rate but does not alter output unless there is economic slack. We establish these results in a small open economy model with downward nominal wage rigidity and provide empirical evidence on the basis of quarterly time-series data for 38 countries.

Keywords: downward nominal wage rigidity, government spending shocks, exchange rate peg, real exchange rate, output, non-linear effects, asymmetric adjustment

JEL Classification: E620, F410, F440

Suggested Citation

Born, Benjamin and D'Ascanio, Francesco and Müller, Gernot J. and Pfeifer, Johannes, The Worst of Both Worlds: Fiscal Policy and Fixed Exchange Rates (2019). CESifo Working Paper No. 7922, Available at SSRN: https://ssrn.com/abstract=3480928

Benjamin Born (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Francesco D'Ascanio

University of Tuebingen ( email )

Wilhelmstr. 19
72074 Tuebingen, Baden Wuerttemberg 72074
Germany

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Johannes Pfeifer

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

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