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Government Spending and the Real Exchange Rate: a Cross - Country Perspective

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  • Rodrigo Caputo
  • Miguel Fuentes

Abstract

In this paper we study, from an empirical point of view, the determinants of the real exchange rate (RER). Relative to the vast previous literature on this topic we aim to distinguish the impact of two important components of government expenditure—public investment and transfers—on the RER, which has usually been neglected. Using panel cointegration techniques, we assess the relevance of those variables in the determination of the RER for a wide set of countries from 1980 to 2009. Our results suggest that changes in either government transfers or public investment have an impact on the RER in emerging economies. On one hand, transfers tend to appreciate the RER because they induce an increase in the relative demand for nontraded goods. On the other, an increase in public investment generates an RER depreciation. This result can be explained by the fact that, in this case, there is an increase in the relative productivity in the nontraded sector of the economy. We also study the effect of countries’ net external assets position on the RER and find that it differs markedly between developed and developing countries: this variable has a significant effect only in the case of developing economies.

Suggested Citation

  • Rodrigo Caputo & Miguel Fuentes, 2012. "Government Spending and the Real Exchange Rate: a Cross - Country Perspective," Working Papers Central Bank of Chile 655, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:655
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    Cited by:

    1. Ibhagui, Oyakhilome, 2017. "Linking Fiscal Policy and External Competitiveness in Sub-Saharan Africa – Does Government Spending Drive The Real Exchange Rate in Sub-Saharan Africa," MPRA Paper 77291, University Library of Munich, Germany, revised 03 Mar 2017.
    2. Álvaro Aguirre R. & César A. Calderón, 2013. "Asimetrías en el Ajuste del Desalineamiento Cambiario en Chile," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 16(3), pages 90-101, December.
    3. Rodrigo Caputo & Mariel Siravegna, 2014. "RER Appreciation After the Great Recession: Misalignment or Fundamental Correction?," Working Papers Central Bank of Chile 718, Central Bank of Chile.
    4. Caputo, Rodrigo, 2015. "Persistent real misalignments and the role of the exchange rate regime," Economics Letters, Elsevier, vol. 135(C), pages 112-116.
    5. Marialuz Moreno Badia & Alex Segura-Ubiergo, 2014. "Real Exchange Rate Appreciation in Emerging Markets; Can Fiscal Policy Help?," IMF Working Papers 14/1, International Monetary Fund.
    6. Prilepskiy, Ilya, 2015. "The impact of fiscal policy on the current account balance and the real exchange rate," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 6, pages 7-23.

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