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Government Purchases and the Real Exchange Rate

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  • Robert Kollmann

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Abstract

Recent empirical research documents that an exogenous rise in government purchases in a given country triggers a persistent depreciation of its real exchange rate - which raises an important puzzle, as standard macro models predict an appreciation of the real exchange rate. This paper presents a simple model with limited international risk sharing that can account for the empirical real exchange rate response. When faced with a country-specific rise in government purchases, local households experience a negative wealth effect; they thus work harder, and domestic output increases. Under balanced trade (financial autarky) this supply-side effect is so strong that the terms of trade worsen, and the real exchange rate depreciates. In a bonds-only economy, an increase in government purchases triggers a real exchange rate depreciation, if the rise in government purchases is sufficiently persistent and/or labor supply is highly elastic.

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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 21 (2010)
Issue (Month): 1 (February)
Pages: 49-64

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Handle: RePEc:kap:openec:v:21:y:2010:i:1:p:49-64

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: Government purchases; Real exchange rate; International risk sharing; F31; F36; F41; F42;

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References

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  1. Andrew Mountford & Harald Uhlig, 2005. "What are the Effects of Fiscal Policy Shocks?," SFB 649 Discussion Papers SFB649DP2005-039, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
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  9. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2008. "International Portfolios, Capital Accumulation and Foreign Assets Dynamics," CEPR Discussion Papers 6902, C.E.P.R. Discussion Papers.
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  12. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  13. Kollmann, R., 1992. "Consumption, Real Exchange Rates and the Structure of International Asset Markets," Cahiers de recherche 9232, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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Citations

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Cited by:
  1. Agustín S. Bénétrix and Philip R. Lane, 2009. "Fiscal Shocks and The Real Exchange Rate," The Institute for International Integration Studies Discussion Paper Series iiisdp286, IIIS.
  2. Hafedh Bouakez & Aurélien Eyquem, 2012. "Government Spending, Monetary Policy, and the Real Exchange Rate," Cahiers de recherche 1212, CIRPEE.
  3. Nicola Acocella, . "A tale of two cities: exit policies in Washington and Frankfurt," Working Papers 117/13, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.
  4. Hyuk Rhee & Nurlan Turdaliev, 2012. "Targeting Rules for an Open Economy," Open Economies Review, Springer, vol. 23(3), pages 447-471, July.
  5. David Fielding, 2011. "New Zealand: The Last Bastion of Textbook Open-Economy Macroeconomics," Working Papers 1105, University of Otago, Department of Economics, revised Jun 2011.
  6. Corsetti, Giancarlo & Meier, André & Müller, Gernot, 2012. "What Determines Government Spending Multipliers?," CEPR Discussion Papers 9010, C.E.P.R. Discussion Papers.
  7. Povoledo, Laura, 2012. "Modelling the sectoral allocation of labour in open economy models," MPRA Paper 40344, University Library of Munich, Germany.
  8. Nicola Acocella, . "The theoretical roots of EMU institutions and policies during the crisis," Working Papers 126/14, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.

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