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Fiscal Shocks, the Trade Balance, and the Exchange Rate

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Faik Koray ()
W. Douglas McMillin ()

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Abstract

This paper investigates empirically, using a VAR model, the response of the exchange rate and the trade balance to fiscal policy shocks for the U.S. economy during the period 1981:3-2006:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the trade balance improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising trade balance deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.

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Paper provided by Department of Economics, Louisiana State University in its series Departmental Working Papers with number 2007-05.

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Handle: RePEc:lsu:lsuwpp:2007-05

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  4. Marianne Baxter, 1995. "International Trade and Business Cycles," NBER Working Papers 5025, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  6. Obstfeld, Maurice, 1981. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1142-61, December. [Downloadable!] (restricted)
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  7. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 168, European Central Bank. [Downloadable!]
  8. Jordi Galí & J. David López-Salido & Javier Vallés, 2004. "Understanding the effects of government spending on consumption," Working Paper Series 339, European Central Bank. [Downloadable!]
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  9. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November. [Downloadable!] (restricted)
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  10. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  11. Yuan, M. & Li, W., 1999. "Dynamic Employment and Hours Effects of Government Spending Shocks," Working Papers 99-1, Bank of Canada.
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  12. Wendy Edelberg & Martin Eichenbaum & Jonas D.M. Fisher, 1998. "Understanding the effects of a shock to government purchases," Working Paper Series WP-98-7, Federal Reserve Bank of Chicago. [Downloadable!]
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  13. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes. [Downloadable!]
  14. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
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  15. Giuseppe de Arcangelis & Serena Lamartina, 2003. "Identifying fiscal shocks and policy regimes in OECD countries," Working Paper Series 281, European Central Bank. [Downloadable!]
  16. Eichenbaum, Martin & Fisher, Jonas D M, 2005. "Fiscal Policy in the Aftermath of 9/11," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(1), pages 1-22, February.
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  17. Kearney, Colm & Monadjemi, Mehdi, 1990. "Fiscal policy and current account performance: International evidence on the twin deficits," Journal of Macroeconomics, Elsevier, vol. 12(2), pages 197-219. [Downloadable!] (restricted)
  18. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
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  19. Flood, Robert P & Marion, Nancy Peregrim, 1982. "The Transmission of Disturbances under Alternative Exchange-Rate Regimes with Optimal Indexing," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 43-66, February. [Downloadable!] (restricted)
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  20. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. José García-Solanes & Jesús Rodríguez López & José Luis Torres Chacón, 2007. "Demand Shocks and Trade Balance Dynamics," Working Papers 07.10, Universidad Pablo de Olavide, Department of Economics. [Downloadable!]
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  2. Bharat Chadha, 2007. "Impact of U.S. Federal Interest Rate and Movement of MSCI on Indian Capital Markets," Working Papers id:1024, esocialsciences.com. [Downloadable!]
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