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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 1981:3-2006:3. 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/pap07_05.pdf
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Paper provided by Department of Economics, Louisiana State University in its series Departmental Working Papers with number 2007-05.

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Handle: RePEc:lsu:lsuwpp:2007-05
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  1. Frenkel, Jacob & razin, assaf & Yuen, chi-wa, 1996. "Fiscal policies and growth in the world economy," MPRA Paper 22109, University Library of Munich, Germany.
  2. Jordi Gali & David López-Salido & Javier Valles, 2004. "Understanding the effects of government spending on consumption," International Finance Discussion Papers 805, Board of Governors of the Federal Reserve System (U.S.).
  3. 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.
  4. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  5. Roberto Perotti, 2002. "Estimating the effects of fiscal policy in OECD countries," Economics Working Papers 015, European Network of Economic Policy Research Institutes.
  6. Baxter, M., 1994. "International Trade and Business Cycles," RCER Working Papers 390, University of Rochester - Center for Economic Research (RCER).
  7. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
  8. Roberto Perotti, 2004. "Estimating the effects of fiscal policy in OECD countries," Working Papers 276, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. de Arcangelis, Giuseppe & Lamartina, Serena, 2003. "Identifying fiscal shocks and policy regimes in OECD countries," Working Paper Series 0281, European Central Bank.
  10. 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.
  11. Maurice Obstfeld, 1980. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation," NBER Working Papers 0599, National Bureau of Economic Research, Inc.
  12. 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.
  13. Perotti, Roberto, 2002. "Estimating the effects of fiscal policy in OECD countries," Working Paper Series 0168, European Central Bank.
  14. Martin Eichenbaum & Jonas Fisher, 2004. "Fiscal Policy in the Aftermath of 9/11," NBER Working Papers 10430, National Bureau of Economic Research, Inc.
  15. 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.
  16. 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.
  17. Mankiw, N, 1987. "Government Purchases and Real Interest Rates," Scholarly Articles 2624457, Harvard University Department of Economics.
  18. Richard Clarida & Joe Prendergast, 1999. "Fiscal Stance and the Real Exchange: Some Empirical Estimates," NBER Working Papers 7077, National Bureau of Economic Research, Inc.
  19. 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.
  20. Yuan, M. & Li, W., 1999. "Dynamic Employment and Hours Effects of Government Spending Shocks," Working Papers 99-1, Bank of Canada.
  21. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  22. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
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