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

Benjamin Born, Francesco D’Ascanio, Gernot Müller and Johannes Pfeifer

No 352, ifo Working Paper Series from ifo Institute - Leibniz Institute for Economic Research at the University of Munich

Abstract: In economies with fixed exchange rates, the adjustment to government spending shocks is asymmetric. A fiscal expansion appreciates the real exchange rate but does not stimulate output. A fiscal contraction does not alter the exchange rate, but lowers output. We develop these insights in a two-sector model of a small open economy with downward nominal wage rigidity. We establish new empirical evidence that supports he predictions of the model along several dimensions: not only does the exchange rate regime shape the fiscal transmission mechanism as predicted by the model – in doing so it also interacts with economic slack and inflation.

Keywords: Downward nominal wage rigidity; government spending shocks; exchangerate peg; real exchange rate; nonlinear effects; asymmetric adjustment; depreciation bias (search for similar items in EconPapers)
JEL-codes: E62 F41 F44 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-cwa, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Mr. Keynes Meets the Classics: Government Spending and the Real Exchange Rate (2024)
Working Paper: Mr. Keynes meets the Classics: Government Spending and the Real Exchange Rate (2019)
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