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Intertemporal adjustment and fiscal policy under a fixed exchange rate regime

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  • Aloy, Marcel
  • Moreno-Dodson, Blanca
  • Nancy, Gilles

Abstract

The paper presents a dynamic model for small to medium open economies operating under a fixed exchange rate regime. The model provides a partial explanation of the channels through which fiscal and monetary policy affects the real exchange rate. An empirical investigation is conducted for the case of Argentina during the currency board period of 1991-2001. Empirical estimates show that fiscal policy may indeed be an efficient instrument for promoting macroeconomic stability insofar as it encourages convergence toward long-run equilibrium and alters the long-term balance between exports and consumption, both private and public. The simulation applied to Argentina shows that if the share of public spending in the economy is higher than the share of imports, an increase in the tax rate will stimulate capital stock slightly, at least in the short term, anddepreciate the real effective exchange rate. In the long run, the fiscal policy affects the value of the real exchange rate and consequently external competitiveness.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4607.

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Date of creation: 01 Apr 2008
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Handle: RePEc:wbk:wbrwps:4607

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Keywords: Currencies and Exchange Rates; Economic Stabilization; Debt Markets; Economic Theory&Research; Emerging Markets;

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  1. Normandin, Michel, 1999. "Budget deficit persistence and the twin deficits hypothesis," Journal of International Economics, Elsevier, vol. 49(1), pages 171-193, October.
  2. McGrattan, Ellen R & Rogerson, Richard & Wright, Randall, 1997. "An Equilibrium Model of the Business Cycle with Household Production and Fiscal Policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(2), pages 267-90, May.
  3. Vittorio Corbo, 2002. "Exchange Rate Regimes in the Americas: Is Dollarization the Solution?," Documentos de Trabajo 229, Instituto de Economia. Pontificia Universidad Católica de Chile..
  4. Pierre-Richard Ag�Nor, 2006. "Market Sentiment and Macroeconomic Fluctuations under Pegged Exchange Rates," Economica, London School of Economics and Political Science, vol. 73(292), pages 579-604, November.
  5. Karras, Georgios, 1994. "Government Spending and Private Consumption: Some International Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 9-22, February.
  6. Enrique Alberola & Luis Molina, 2000. "Fiscal Discipline and Exchange Rate Regimes: a Case for Currency Boards?," Banco de Espa�a Working Papers 0006, Banco de Espa�a.
  7. Betty Daniel, 2000. "A Fiscal Theory of Currency Crises," Econometric Society World Congress 2000 Contributed Papers 0535, Econometric Society.
  8. Chang, Wen-Ya & Tsai, Hsueh-Fang, 1998. "Government Spending and Real Interest Rate in an Open Economy," Review of International Economics, Wiley Blackwell, vol. 6(2), pages 284-91, May.
  9. Serven, Luis & Frankel, Jeffrey & Fajnzylber, Eduardo & Schmukler, Sergio, 2000. "Verifying exchange rate regimes," Policy Research Working Paper Series 2397, The World Bank.
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