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Exchange Rates and Fiscal Adjustments: Evidence from the OECD and Implications for the EMU

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Author Info

  • Lambertini Luisa

    ()
    (Boston College and University of California, Los Angeles)

  • Tavares José A

    ()
    (Universidade Nova de Lisboa)

Abstract

This paper investigates whether monetary and exchange rate policies are important for the success of major fiscal adjustments. We assess their role controlling for other determinants of success identified in the literature, including the size and composition of the deficit cut, the level of public debt and the rate of economic growth. We find that successful adjustments are preceded by exchange rate depreciations. Empirically, a depreciation of the nominal effective exchange of one standard deviation of the sample mean in the two years before an adjustment increases the probability of success by 2 percentage points. The size and composition of the deficit cut are also important determinants of success: an increase of one standard deviation of the sample mean raises the probability of success by 3 and 4 percentage points, respectively. One implication of our results is that it may be more difficult to attain persistent fiscal adjustments within the Economic and Monetary Union of Europe, since the adoption of a single currency rules out the use of exchange rate policy among member countries.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 5 (2005)
Issue (Month): 1 (December)
Pages: 1-30

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Handle: RePEc:bpj:bejmac:v:contributions.5:y:2005:i:1:n:11

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Cited by:
  1. Antonio Afonso, 2010. "Expansionary fiscal consolidations in Europe: new evidence," Applied Economics Letters, Taylor & Francis Journals, vol. 17(2), pages 105-109.
  2. Larch, Martin & Turrini, Alessandro, 2008. "Received wisdom and beyond: Lessons from fiscal consolidations in the EU," MPRA Paper 20604, University Library of Munich, Germany.
  3. Alexander Plekhanov & Manmohan S. Kumar & Daniel Leigh, 2007. "Fiscal Adjustments," IMF Working Papers 07/178, International Monetary Fund.
  4. Mati, Amine & Thornton, John, 2008. "The exchange rate and fiscal consolidation episodes in emerging market economies," Economics Letters, Elsevier, vol. 100(1), pages 115-118, July.
  5. Athanasios Tagkalakis, 2009. "Fiscal adjustments: do labor and product market institutions matter?," Public Choice, Springer, vol. 139(3), pages 389-411, June.
  6. Tavares, Jose, 2004. "Does right or left matter? Cabinets, credibility and fiscal adjustments," Journal of Public Economics, Elsevier, vol. 88(12), pages 2447-2468, December.
  7. Tagkalakis, Athanasios, 2011. "Fiscal adjustments and asset price changes," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 206-223, June.
  8. António Afonso, 2007. "Expansionary fiscal consolidations in Europe: part of conventional wisdom?," Money Macro and Finance (MMF) Research Group Conference 2006 50, Money Macro and Finance Research Group.

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