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Fiscal Discipline and Exchange Rate Regimes

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  • Rupa Duttagupta
  • Guillermo Tolosa
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    Abstract

    This paper assesses the nature of fiscal discipline under alternative exchange rate regimes. First, it shows in a simple theoretical framework that fiscal agencies under a currency union with a fixed exchange rate can have the largest incentive to overspend or "free-ride" (compared to those under other exchange rate regimes) owing to their ability to spread the costs of overspending in terms of the inflation tax across both time-given the fixed exchange rate-and space-given the currency union. In contrast, such free-riding behavior does not arise under flexible regimes owing to the immediate inflationary impact of spending. Next, empirically, it shows that fiscal stances in countries with fixed pegs and currency unions regime demonstrate greater free-riding behavior than countries with more flexible regimes in 15 Caribbean countries during 1983-2004.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/119.

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    Length: 37
    Date of creation: 01 May 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/119

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    Keywords: Fiscal policy; Exchange rates; Exchange rate regimes; Flexible exchange rates; Currency pegs; exchange rate; fiscal stances; fixed exchange rate; fiscal policies; fiscal discipline; fiscal stance; government spending; fixed exchange rates; exchange rate regime; alternative exchange rate; alternative exchange rate regimes; fiscal incentives; currency unions; budget constraint; fiscal authorities; flexible exchange rate; fiscal performance; fiscal deficits; primary expenditure; fiscal expansion; fiscal agencies; public debt; fixed exchange rate regimes; fixed exchange rate regime; fiscal balances; fiscal revenue; government budget; flexible exchange rate regime; exchange rate arrangements; fiscal behavior; fiscal spending; fiscal revenues; government budget constraint; fiscal profligacy; budget constraints; fiscal outcomes; fiscal balance; flexible exchange rate regimes; fiscal solvency; exchange restrictions; fiscal effort; exchange arrangements; fiscal indiscipline; fixed ? exchange rate; flexible ? exchange rates; floating exchange rate regime; social expenditure; government budget constraints; fiscal imbalances; expansionary fiscal policy; nominal exchange rate; fiscal constraint; fiscal expenditure; intergovernmental fiscal relations; primary fiscal balance; fiscal rules; fiscal efforts; public deficits; fiscal expansions; fiscal sustainability; exchange rate policies; fiscal reforms; expansionary fiscal; budget deficits; intergovernmental fiscal; classification of exchange rate; fiscal transparency; government expenditures; current exchange rate; expenditure growth; de facto exchange rate regime; exchange rate system; prevailing exchange rate; fiscal agents; primary deficit; budget process; fiscal relations; exchange rate stability; floating exchange rate; fiscal constraints;

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    Citations

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    Cited by:
    1. Shaun K. Roache, 2007. "Public Investment and Growth in the Eastern Caribbean," IMF Working Papers 07/124, International Monetary Fund.
    2. Rui Ota & Stephanie Medina Cas, 2008. "Big Government, High Debt, and Fiscal Adjustment in Small States," IMF Working Papers 08/39, International Monetary Fund.
    3. Hallerberg, Mark & Wolff, Guntram B., 2006. "Fiscal institutions, fiscal policy and sovereign risk premia," Discussion Paper Series 1: Economic Studies 2006,35, Deutsche Bundesbank, Research Centre.

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