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

  • Luisa Lambertini

    ()

    (Boston College)

  • Jose Tavares

    ()

    (Universidade Nova, Lisbon)

We study monetary and exchange-rate policies around successful and unsuccessful fiscal adjustments and find that successful adjustments are preceded by large nominal exchange rate depreciations, whereas unsuccessful adjustments are preceded by appreciations. Pre-adjustment depreciation is a significant and quantitatively important predictor of the success of adjustment. Our results are robust to the inclusion of other determinants of the success of adjustment and to the definition of the depreciation period, of the persistence of the adjustment, and of the exchange rate. Monetary policy does not affect the success of fiscal adjustments. This result is confirmed when the sample is divided into countries that follow a fixed exchange rate policy and those that do not: for both cases it is exchange rate depreciations that affect the likelihood of success. Our results suggest that the adoption of a single currency will make successful fiscal adjustments more difficult to attain within EMU.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 576.

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Length: 25 pages
Date of creation: 01 Aug 2003
Date of revision:
Handle: RePEc:boc:bocoec:576
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  1. Giuseppe Bertola & Allan Drazen, 1991. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," NBER Working Papers 3844, National Bureau of Economic Research, Inc.
  2. Francesco Giavazzi & Marco Pagano, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," NBER Working Papers 5332, National Bureau of Economic Research, Inc.
  3. Francesco Giavazzi & Tullio Jappelli & Marco Pagano, 2000. "Searching for Non-Linear Effects of Fiscal Policy: Evidence from Industrial and Developing Countries," NBER Working Papers 7460, National Bureau of Economic Research, Inc.
  4. Alesina, Alberto Francesco & Perotti, Roberto & Tavares, Jose, 1998. "The Political Economy of Fiscal Adjustments," Scholarly Articles 12553724, Harvard University Department of Economics.
  5. Lane, Philip R. & Perotti, Roberto, 1998. "The trade balance and fiscal policy in the OECD," European Economic Review, Elsevier, vol. 42(3-5), pages 887-895, May.
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  7. Martin Feldstein, 1980. "Government Deficits and Aggregate Demand," NBER Working Papers 0435, National Bureau of Economic Research, Inc.
  8. Eichengreen, Barry, 1993. "European Monetary Unification," Journal of Economic Literature, American Economic Association, vol. 31(3), pages 1321-57, September.
  9. Maurice Obstfeld, 1999. "EMU: Ready, or Not?," NBER Working Papers 6682, National Bureau of Economic Research, Inc.
  10. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  11. Alberto Alesina & Roberto Perotti & José Tavares, 1998. "The Political Economy of Fiscal Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 197-266.
  12. Roberto Perotti, 1999. "Fiscal Policy In Good Times And Bad," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1399-1436, November.
  13. Alberto Alesina & Roberto Perotti, 1997. "Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects," IMF Staff Papers, Palgrave Macmillan, vol. 44(2), pages 210-248, June.
  14. Barry Eichengreen & Charles Wyplosz, 1998. "The Stability Pact: more than a minor nuisance?," Economic Policy, CEPR;CES;MSH, vol. 13(26), pages 65-113, 04.
  15. Schuknecht, Ludger, 1998. "Fiscal policy cycles and the exchange regime in developing countries," WTO Staff Working Papers ERAD-97-04, World Trade Organization (WTO), Economic Research and Statistics Division.
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