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The external effects of public sector deficits

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  • Rodriguez, Carlos Alfredo

Abstract

This paper develops a two equation model for measuring how public sector deficits - and the way that they are financed - affect the real exchange rate, the trade balance, the current account and the level of external indebtedness. One equation relates the real exchange rate to the trade surplus and the other describes the trade surplus as a function of structural parameters, the fiscal deficit, and the stock of foreign assets. To make the model dynamic, one must allow for the fact that the level of foreign assets - one determinant of the trade surplus and current account - changes over time. The trade surplus, plus foreign internest earned, determines the evolution over time of the stock of foreign assets. Using this model, the paper makes the following conclusions. The level and composition of government spending affects the real exchange rate because of the effect of spending on nontraded goods. Changes in the trade balance are also bound to affect the real exchange rate. How much depends on how much expenditure must be switched to make the trade balance compatible with the change in aggregate spending.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 299.

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Date of creation: 30 Nov 1989
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Handle: RePEc:wbk:wbrwps:299

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Related research

Keywords: Economic Theory&Research; Economic Stabilization; Environmental Economics&Policies; Macroeconomic Management; Public Sector Economics&Finance;

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References

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  1. Rodriguez, Carlos Alfredo, 1989. "Macroeconomic policies for structural adjustment," Policy Research Working Paper Series 247, The World Bank.
  2. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-25, June.
  3. Dornbusch, Rudiger, 1973. "Currency Depreciation, Hoarding, and Relative Prices," Journal of Political Economy, University of Chicago Press, vol. 81(4), pages 893-915, July-Aug..
  4. Dornbusch, Rudiger, 1974. "Tariffs and nontraded goods," Journal of International Economics, Elsevier, vol. 4(2), pages 177-185, May.
  5. Jacob A. Frenkel & Carlos A. Rodriguez, 1982. "Exchange Rate Dynamics and the Overshooting Hypothesis," NBER Working Papers 0832, National Bureau of Economic Research, Inc.
  6. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-94, June.
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Citations

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Cited by:
  1. Faini, Riccardo & de Melo, Jaime, 1991. "Fiscal issues in adjustment : an introduction," Policy Research Working Paper Series 724, The World Bank.
  2. Baffes, John & Elbadawi, Ibrahim A. & O'Connell, Stephen A., 1997. "Single-equation estimation of the equilibrium real exchange rate," Policy Research Working Paper Series 1800, The World Bank.
  3. Marcelo Dabos & V. Hugo Juan- Ramon, 1998. "Real Exchange Rate Response to Capital Flows in Mexico: An Empirical Analysis," Working Papers 21, Universidad de San Andres, Departamento de Economia, revised Dec 1999.
  4. Satish Chand, 2001. "How misaligned is the Australian real exchange rate?," International and Development Economics Working Papers idec01-2, International and Development Economics.
  5. Marco Arnone & Luca Bandiera & Andrea Presbitero, 2005. "External Debt Sustainability: Theory and Empirical Evidence," International Finance 0512007, EconWPA.
  6. Larry A. Sjaastad & Meher Manzur, 2003. "Import Protection, Capital Inflows, and Real Exchange Rate Dynamics," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 177-203, May.
  7. Soledad Arellano & Felipe Larraín, 1996. "Tipo de Cambio Real y Gasto Público: Un Modelo Econométrico para Chile," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 47-76.
  8. Easterly, William & Schmidt-Hebbel, Klaus, 1991. "The macroeconomics of public sector deficits : a synthesis," Policy Research Working Paper Series 775, The World Bank.

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