Fiscal Policy and the Real Exchange Rate

Abstract

Government spending on infrastructure has recently increased sharply in many emerging-market economies. This paper examines the mechanism through which public infrastructure spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral adjustment costs, we show that government spending generates a nonmonotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal tradeoffs. The effect of government spending on the real exchange rate depends critically on (i) the composition of public spending, (ii) the underlying financing policy, (iii) the intensity of private capital in production, and (iv) the relative productivity of public infrastructure. In deriving these results, the model also identifies conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities, namely the intertemporal relationship between government spending, private consumption, and the real exchange rate.

Optimal fiscal management of commodity price shocks

“…While this assumption has some appeal (especially if shifting resources from producing one type of goods to another occurs can be done quickly and within the same production units) it is worth considering the case where mobility is imperfect, as in some contributions. In Morshed and Turnovsky (2004) and Chatterjee and Mursagulov (2012) for instance, there are convex costs of transferring private capital across sectors.…”