Profitability, Fiscal Policy, and Exchange Rate Regimes
AbstractIn this paper, we study the link between profitability, fiscal policy and exchange rate regimes. We are particularly interested in adding realism to the treatment of fiscal policy by looking explicitly at its individual components. We show that the different types of government spending and taxation affect profitability through two main channels, namely changes in labour costs and movements in the nominal exchange rate when the exchange rate is flexible. This also implies that the different components of fiscal policy have different effects on profitability depending on the exchange rate regime. Using a panel of OECD countries over 1960–94, we find considerable empirical support for the predictions of our model. Increases in government wage consumption lead to higher labour costs and a nominal exchange rate appreciation; hence, they have a stronger negative impact on profitability under a flexible exchange rate regime. The opposite holds for increases in labour taxation. In contrast, and in line with our model, government non-wage consumption and transfers have only minor effects on exchange rates and profitability, and regime effects are small in these cases. The implication for countries attempting a fiscal adjustment is that its impact on profitability depends critically on the composition of the fiscal adjustment and on the exchange rate policy.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1449.
Date of creation: Jul 1996
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Find related papers by JEL classification:
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
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- Lane, Philip R. & Perotti, Roberto, 1998. "The trade balance and fiscal policy in the OECD," European Economic Review, Elsevier, vol. 42(3-5), pages 887-895, May.
- Carlos Mulas-Granados, 2005. "Fiscal Adjustments and the Short-Term Trade-Off between economic growth and equality," Hacienda Pública Española, IEF, vol. 172(1), pages 61-92, June.
- Carlos Mulas-Granados, 2003. "The Trade-Off between Growth & Equality and the Economic Impact of Alternative Fiscal Adjustment Strategies in the EU," European Economy Group Working Papers 20, European Economy Group.
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