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Public investment and real exchange rate dynamics: The role of public capital productivity

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  • Dissou, Yazid
  • Ma, Sicong

Abstract

This paper investigates how public investment influences real exchange rate dynamics. While most empirical studies find that higher government investment appreciates the real exchange rate, theory often predicts depreciation. We develop an open-economy New Keynesian model with tradable and nontradable sectors, nominal rigidities, and productive public capital to reconcile these findings. Using China as a case study, we show that the productivity of public capital – the extent to which public investment enhances private-sector efficiency – is decisive. Low productivity causes a real appreciation, whereas high productivity leads to depreciation. The model thus explains the mixed empirical evidence on fiscal policy and the exchange rate. The results highlight that the competitiveness impact of public investment depends on how productive it is.

Suggested Citation

  • Dissou, Yazid & Ma, Sicong, 2026. "Public investment and real exchange rate dynamics: The role of public capital productivity," Economic Modelling, Elsevier, vol. 155(C).
    • Handle: RePEc:eee:ecmode:v:155:y:2026:i:c:s0264999325004468
    DOI: 10.1016/j.econmod.2025.107451
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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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures

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