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Fiscal Foresight, Forecast Revisions and the Effects of Government Spending in the Open Economy

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  • Luca Gambetti

Abstract

This paper investigates the effects of government spending on the real exchange rate and the trade balance in the US using a new VAR identification procedure based on spending forecast revisions. I find that the real exchange rate appreciates and the trade balance deteriorates after a government spending shock, although the effects are quantitatively small. The findings broadly match the theoretical predictions of the standard Mundell-Fleming model and differ substantially from those existing in literature. Differences are attributable to the fact that, because of fiscal foresight, the government spending is non-fundamental for the variables typically used in open economy VARs. Here, on the contrary, the estimated shock is fundamental.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 644.

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Date of creation: May 2012
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Handle: RePEc:bge:wpaper:644

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Keywords: VARs; fiscal policy; twin deficits; trade balance; Mundell-Fleming; forecast revisions; fiscal news; survey of professional forecasters;

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References

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  1. Morten O. Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2007. "Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate," Economics Working Papers ECO2007/23, European University Institute.
  2. Robert Kollmann, 1998. "U.S. trade balance dynamics: the role of fiscal policy and productivity shocks and of financial market linkages," ULB Institutional Repository 2013/7634, ULB -- Universite Libre de Bruxelles.
  3. R. Barrell & R. Anderton & G.M. Caporale & J.W. in't Veld, 1993. "The World Economy," National Institute Economic Review, National Institute of Economic and Social Research, vol. 145(1), pages 43-63, August.
  4. Corsetti, Giancarlo & Meier, André & Müller, Gernot, 2009. "Fiscal Stimulus with spending reversals," CEPR Discussion Papers 7302, C.E.P.R. Discussion Papers.
  5. Qiang Dai & Thomas Philippon, 2005. "Fiscal Policy and the Term Structure of Interest Rates," NBER Working Papers 11574, National Bureau of Economic Research, Inc.
  6. Baxter, Marianne, 1995. "International trade and business cycles," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 35, pages 1801-1864 Elsevier.
  7. Enders, Zeno & Müller, Gernot J. & Scholl, Almuth, 2011. "How do fiscal and technology shocks affect real exchange rates?: New evidence for the United States," Journal of International Economics, Elsevier, vol. 83(1), pages 53-69, January.
  8. Mario Forni & Luca Gambetti, 2010. "Fiscal Foresight and the Effects of Government Spending," Center for Economic Research (RECent) 049, University of Modena and Reggio E., Dept. of Economics.
  9. Eric M. Leeper & Todd B. Walker & Shu-Chun Susan Yang, 2008. "Fiscal Foresight: Analytics and Econometrics," Caepr Working Papers 2008-013, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  10. Marianne Baxter, 1995. "International Trade and Business Cycles," NBER Working Papers 5025, National Bureau of Economic Research, Inc.
  11. Maurice Obstfeld & Kenneth Rogoff, 1996. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
  12. Plosser, Charles I., 1987. "Fiscal policy and the term structure," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 343-367, September.
  13. Mertens, Karel & Ravn, Morten O., 2009. "Measuring the Impact of Fiscal Policy in the Face of Anticipation: A Structural VAR Approach," CEPR Discussion Papers 7423, C.E.P.R. Discussion Papers.
  14. A. S. Benetrix & P. R. Lane, 2013. "Fiscal Shocks and the Real Exchange Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 9(3), pages 6-37, September.
  15. Roel Beetsma & Massimo Giuliodori & Franc Klaassen, 2008. "The Effects of Public Spending Shocks on Trade Balances and Budget Deficits in the European Union," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 414-423, 04-05.
  16. Roberto perotti, 2011. "Expectations and Fiscal Policy: An Empirical Investigation," Working Papers 429, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  17. Roel Beetsma & Massimo Giuliodori, 2011. "The Effects of Government Purchases Shocks: Review and Estimates for the EU," Economic Journal, Royal Economic Society, vol. 121(550), pages F4-F32, February.
  18. Elmendorf, D.W., 1993. "Actual Budget Deficit Expectations and Interest Rates," Harvard Institute of Economic Research Working Papers 1639, Harvard - Institute of Economic Research.
  19. Mario Forni & Luca Gambetti, 2011. "Sufficient information in structural VARs," Center for Economic Research (RECent) 062, University of Modena and Reggio E., Dept. of Economics.
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Cited by:
  1. Giacomo De Giorgi & Luca Gambetti, 2012. "The Effects of Government Spending on the Distribution of Consumption," UFAE and IAE Working Papers 905.12, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).

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