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Fiscal Consolidations under Fixed Exchange Rates

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  • Paola Casell

    ()
    (Banca d'Italia)

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    Abstract

    We present the “fixed exchange rate” version of the Obstfeld and Rogoff model and analyze the international transmission of fiscal policy shocks. It is shown that the welfare effects of an unanticipated contraction in government expenditure in the home country crucially depend on the way in which world money stock is set. If home authorities alone are responsible for pegging the exchange rate, a fiscal adjustment induces a decrease in the real interest rate, stimulates private consumption and limits the contraction in world output, compared with a situation in which a cooperative scheme is implemented. The model is then used to propose a new interpretation of recent events in the EU countries that have enacted restrictive fiscal policies while pegging their currencies to the DM.

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    File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td98/td336_98/td336en/tema_336_98.pdf
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    Bibliographic Info

    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 336.

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    Date of creation: Oct 1998
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    Handle: RePEc:bdi:wptemi:td_336_98

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    Web page: http://www.bancaditalia.it
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    Related research

    Keywords: exchange rate; social welfare; fiscal policy;

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    References

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    1. Cipollone Piero & Marchetti Domenico J., 1998. "Strozzature settoriali, limiti alla crescita e pressioni inflazionistiche," Rivista italiana degli economisti, Società editrice il Mulino, issue 1, pages 27-54.
    2. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
    3. Perotti, Roberto & Alesina, Alberto, 1997. "The Welfare State and Competitiveness," Scholarly Articles 4553027, Harvard University Department of Economics.
    4. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche 9614, Universite de Montreal, Departement de sciences economiques.
    5. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
    6. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1997. "Monetary Shocks and Real Exchange Rates in Sticky Price Models of International Business Cycles," NBER Working Papers 5876, National Bureau of Economic Research, Inc.
    7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
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    Cited by:
    1. Lane, Philip R., 1999. "The New Open Economy Macroeconomics: a Survey," CEPR Discussion Papers 2115, C.E.P.R. Discussion Papers.

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