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Fiscal Policy under Flexible Exchange Rates: When is Expansion Contractionary?

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  • Pekka Ahtiala
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    Abstract

    In this paper the behaviour functions are specified to correspond to their foundations in closed-economy macrotheory . The demand for real money balances, in terms of the expenditure basket of goods, is specified as a function of income in terms of the same basket. Imports are specified as a function of expenditures, being functionally part of expenditures. The supply of labor is specified as a function of the expenditure price. Fiscal expansion, while expansionary in the real wage model, turns out to be expansionary, neutral, or contractionary in the money wage model depending on whether the income elasticity of the demand for money is smaller than, equal to, or greater than one, also in the long run. However, if interest payments on foreign securities are not smaller relative to the trade balance, many of the effects are reversed. Output and the exchange rate overshoot their steady-state levels in both cases. [E1, F41]

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal International Economic Journal.

    Volume (Year): 12 (1998)
    Issue (Month): 2 ()
    Pages: 17-34

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    Handle: RePEc:taf:intecj:v:12:y:1998:i:2:p:17-34

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    References

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    1. Ahtiala, Pekka, 1987. "The effects of foreign disturbances under flexible exchange rates," Journal of International Money and Finance, Elsevier, vol. 6(4), pages 387-400, December.
    2. Stephen M. Goldfeld, 1973. "The Demand for Money Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(3), pages 577-646.
    3. Ahtiala, Pekka, 1989. "A note on fiscal policy under flexible exchange rates," European Economic Review, Elsevier, vol. 33(7), pages 1481-1486, September.
    4. Sachs, Jeffrey, 1980. "Wages, Flexible Exchange Rates, and Macroeconomic Policy," The Quarterly Journal of Economics, MIT Press, vol. 94(4), pages 731-47, June.
    5. Ahtiala, Pekka, 1984. "A synthesis of the macroeconomic approaches to exchange rate determination," European Economic Review, Elsevier, vol. 24(2), pages 117-136, March.
    6. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-71, December.
    7. Michael Devereux & Douglas D. Purvis, 1984. "Fiscal Policy and the Real Exchange Rate," Working Papers 593, Queen's University, Department of Economics.
    8. Scarth, William M., 1979. "Bond financed fiscal policy and the problem of instrument instability," Journal of Macroeconomics, Elsevier, vol. 1(1), pages 107-117.
    9. William H. Branson & Willem H. Buiter, 1983. "Monetary and Fiscal Policy with Flexible Exchange Rates," NBER Working Papers 0901, National Bureau of Economic Research, Inc.
    10. Dornbusch, Rudiger, 1975. "A portfolio balance model of the open economy," Journal of Monetary Economics, Elsevier, vol. 1(1), pages 3-20, January.
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    Cited by:
    1. Ahtiala, Pekka, 1998. "Monetary policy under flexible exchange rates: When is expansion contractionary?," International Review of Economics & Finance, Elsevier, vol. 7(4), pages 361-378.

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