Government Spending and the Real Exchange Rate
I study the effect of government spending on the real exchange rate in a model exhibiting complementarily between consumption at different points in time. I show that the standard result of fiscal expansions causing real appreciations may hold, although not always, in this intertemporal framework. I also examine the time series from a cross section of European countries for the period 1970-1982 and find that the standard result is supported by the data. More importantly, I show that increases in government expenditures appear to have been the single most important cause behind the decline of the manufacturing sector in those countries.
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