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Mr. Keynes meets the Classics: Government Spending and the Real Exchange Rate

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  • Born, Benjamin
  • D'Ascanio, Francesco
  • Müller, Gernot
  • Pfeifer, Johannes

Abstract

In economies with fixed exchange rates, the adjustment to government spending shocks is asymmetric. Expansionary shocks are absorbed by the real exchange rate, contractionary shocks by output. This result emerges in a small open economy model with downward nominal wage rigidity and is supported by new empirical evidence based on panel data from different exchange-rate regimes. The exchange-rate regime, economic slack, inflation, and how spending is financed all matter for the fiscal transmission mechanism in the way predicted by the model. Estimates that fail to distinguish between the effects of positive and negative shocks are subject to a "depreciation bias".

Suggested Citation

  • Born, Benjamin & D'Ascanio, Francesco & Müller, Gernot & Pfeifer, Johannes, 2019. "Mr. Keynes meets the Classics: Government Spending and the Real Exchange Rate," CEPR Discussion Papers 14073, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:14073
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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
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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