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Fiscal Shocks, the Trade Balance, and the Exchange Rate

This paper investigates empirically, using a VAR model, the response of the exchange rate and the trade balance to fiscal policy shocks for the U.S. economy during the period 1981:3-2005:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the trade balance improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising trade balance deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.

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File URL: http://www.bus.lsu.edu/economics/papers/pap06_02.pdf
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Paper provided by Department of Economics, Louisiana State University in its series Departmental Working Papers with number 2006-02.

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Handle: RePEc:lsu:lsuwpp:2006-02
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  1. Robert P. Flood & Nancy Peregrim Marion, 1980. "The Transmission of Disturbances under Alternative Exchange-Rate Regimeswith Optimal Indexing," NBER Working Papers 0500, National Bureau of Economic Research, Inc.
  2. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  3. Frenkel, Jacob & razin, assaf & Yuen, chi-wa, 1996. "Fiscal policies and growth in the world economy," MPRA Paper 22109, University Library of Munich, Germany.
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  11. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  12. Richard Clarida & Joe Prendergast, 1999. "Fiscal Stance and the Real Exchange: Some Empirical Estimates," NBER Working Papers 7077, National Bureau of Economic Research, Inc.
  13. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
  14. Wendy Edelberg & Martin Eichenbaum & Jonas D.M. Fisher, 1998. "Understanding the Effects of a Shock to Government Purchases," NBER Working Papers 6737, National Bureau of Economic Research, Inc.
  15. 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.
  16. de Arcangelis, Giuseppe & Lamartina, Serena, 2003. "Identifying fiscal shocks and policy regimes in OECD countries," Working Paper Series 0281, European Central Bank.
  17. Marianne Baxter, 1995. "International Trade and Business Cycles," NBER Working Papers 5025, National Bureau of Economic Research, Inc.
  18. Martin Eichenbaum & Jonas Fisher, 2004. "Fiscal policy in the aftermath of 9/11," Working Paper Series WP-04-06, Federal Reserve Bank of Chicago.
  19. Yuan, M. & Li, W., 1999. "Dynamic Employment and Hours Effects of Government Spending Shocks," Working Papers 99-1, Bank of Canada.
  20. Obstfeld, Maurice, 1981. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1142-61, December.
  21. Kearney, Colm & Monadjemi, Mehdi, 1990. "Fiscal policy and current account performance: International evidence on the twin deficits," Journal of Macroeconomics, Elsevier, vol. 12(2), pages 197-219.
  22. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers.
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