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Exchange Rates and Fiscal Adjustments: Evidence from the OECD and Implications for the EMU

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  • Lambertini Luisa

    () (Boston College and University of California, Los Angeles)

  • Tavares José A

    () (Universidade Nova de Lisboa)

Abstract

This paper investigates whether monetary and exchange rate policies are important for the success of major fiscal adjustments. We assess their role controlling for other determinants of success identified in the literature, including the size and composition of the deficit cut, the level of public debt and the rate of economic growth. We find that successful adjustments are preceded by exchange rate depreciations. Empirically, a depreciation of the nominal effective exchange of one standard deviation of the sample mean in the two years before an adjustment increases the probability of success by 2 percentage points. The size and composition of the deficit cut are also important determinants of success: an increase of one standard deviation of the sample mean raises the probability of success by 3 and 4 percentage points, respectively. One implication of our results is that it may be more difficult to attain persistent fiscal adjustments within the Economic and Monetary Union of Europe, since the adoption of a single currency rules out the use of exchange rate policy among member countries.

Suggested Citation

  • Lambertini Luisa & Tavares José A, 2005. "Exchange Rates and Fiscal Adjustments: Evidence from the OECD and Implications for the EMU," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-30, December.
  • Handle: RePEc:bpj:bejmac:v:contributions.5:y:2005:i:1:n:11
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    Citations

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    Cited by:

    1. Tavares, Jose, 2004. "Does right or left matter? Cabinets, credibility and fiscal adjustments," Journal of Public Economics, Elsevier, vol. 88(12), pages 2447-2468, December.
    2. Georgia Kaplanoglou & Vassilis T. Rapanos & Ioanna C. Bardakas, 2015. "Does Fairness Matter for the Success of Fiscal Consolidation?," Kyklos, Wiley Blackwell, vol. 68(2), pages 197-219, May.
    3. Christoph A. Schaltegger & Martin Weder, 2010. "Are Fiscal Adjustments Bad for Investment?," CREMA Working Paper Series 2010-17, Center for Research in Economics, Management and the Arts (CREMA).
    4. Martin Larch & Alessandro Turrini, 2011. "Received Wisdom And Beyond: Lessons From Fiscal Consolidation In The Eu," National Institute Economic Review, National Institute of Economic and Social Research, vol. 217(1), pages 1-18, July.
    5. Alexander Plekhanov & Manmohan S. Kumar & Daniel Leigh, 2007. "Fiscal Adjustments; Determinants and Macroeconomic Consequences," IMF Working Papers 07/178, International Monetary Fund.
    6. António Afonso, 2010. "Expansionary fiscal consolidations in Europe: new evidence," Applied Economics Letters, Taylor & Francis Journals, vol. 17(2), pages 105-109, January.
    7. Alberto Alesina & Silvia Ardagna, 2013. "The Design of Fiscal Adjustments," Tax Policy and the Economy, University of Chicago Press, vol. 27(1), pages 19-68.
    8. Athanasios Tagkalakis, 2009. "Fiscal adjustments: do labor and product market institutions matter?," Public Choice, Springer, vol. 139(3), pages 389-411, June.
    9. António Afonso, 2007. "Expansionary fiscal consolidations in Europe: part of conventional wisdom?," Money Macro and Finance (MMF) Research Group Conference 2006 50, Money Macro and Finance Research Group.
    10. Tagkalakis, Athanasios, 2011. "Fiscal adjustments and asset price changes," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 206-223, June.
    11. Mati, Amine & Thornton, John, 2008. "The exchange rate and fiscal consolidation episodes in emerging market economies," Economics Letters, Elsevier, vol. 100(1), pages 115-118, July.
    12. Kleis, Mischa & Moessinger, Marc-Daniel, 2016. "The long-run effect of fiscal consolidation on economic growth: Evidence from quantitative case studies," ZEW Discussion Papers 16-047, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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