In order to understand the dynamic effects of government spending on foreign trade the present paper proceeds in two steps. First, using U.S. time series data for the post-Bretton-Woods period, the dynamic effects of government spending are investigated within a structural Vector Autoregression framework: the nominal exchange rate is found to depreciate, the terms of trade to appreciate and the trade balance to increase significantly after a temporary increase in government spending. In a second step, a New-Keynesian general equilibrium model is used to rationalize these effects. Two findings emerge: i) a low elasticity of substitution between home and foreign goods is necessary for the trade balance to improve after an increase in public spending. ii) an accommodating monetary policy is found to dampen the effects of government spending on foreign trade.
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Paper provided by European University Institute in its series Economics Working Papers with number
ECO2004/27.
Length: Date of creation: 2004 Date of revision: Handle: RePEc:eui:euiwps:eco2004/27
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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 F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
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