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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
    DOI: 10.2202/1534-6005.1168
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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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