Questioning the Puzzle: Fiscal Policy, Real Exchange Rate and Inflation

40 Pages Posted: 14 Apr 2021

See all articles by Laurent Ferrara

Laurent Ferrara

SKEMA Business School; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA); Université Paris Ouest - Nanterre, La Défense - EconomiX

Luca Metelli

Bank of Italy

Filippo Natoli

Bank of Italy

Daniele Siena

Banque de France

Date Written: April 8, 2021

Abstract

The paper re-investigates the effects of government spending shocks on the real exchange rate and inflation, using US data. In opposition to some previous puzzling results, we find that an increase in government spending appreciates the real exchange rate and generates inflationary pressures. Positive spending shocks also induce a trade balance deficit and an increase in the nominal interest rate. The discrepancy with the existing literature lies in the identification of fiscal shocks: embedding a narrative instrument within a proxy-SVAR model is what makes the difference. Findings are robust and coherent with a standard open economy business cycle model. Our analysis suggests that proxy-SVAR models are more immune to structural changes in US fiscal policy.

Keywords: Fiscal shocks, real exchange rate, inflation, proxy-SVAR, narrative shocks

JEL Classification: E62, F41

Suggested Citation

Ferrara, Laurent and Metelli, Luca and Natoli, Filippo and Siena, Daniele, Questioning the Puzzle: Fiscal Policy, Real Exchange Rate and Inflation (April 8, 2021). CAMA Working Paper No. 38/2021, Available at SSRN: https://ssrn.com/abstract=3822101 or http://dx.doi.org/10.2139/ssrn.3822101

Laurent Ferrara (Contact Author)

SKEMA Business School ( email )

Paris la Défense, 92916
France

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

200 Avenue de la République
92000

Luca Metelli

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Filippo Natoli

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Daniele Siena

Banque de France ( email )

Paris
France

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