Floats, pegs and the transmission of fiscal policy

Giancarlo Corsetti, Keith Kuester and Gernot Müller

No 11-9, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: According to conventional wisdom, fiscal policy is more effective under a fixed than under a flexible exchange rate regime. In this paper the authors reconsider the transmission of shocks to government spending across these regimes within a standard New Keynesian model of a small open economy. Because of the stronger emphasis on intertemporal optimization, the New Keynesian framework requires a precise specification of fiscal and monetary policies, and their interaction, at both short and long horizons. The authors derive an analytical characterization of the transmission mechanism of expansionary spending policies under a peg, showing that the long-term real interest rate always rises in response to an increase in government spending if inflation rises initially. This response drives down private demand even though short-term real rates fall. As this need not be the case under floating exchange rates, the conventional wisdom needs to be qualified. Under plausible medium-term fiscal policies, government spending is not necessarily less expansionary under floating exchange rates.

Keywords: Fiscal policy; Monetary policy (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba and nep-mac
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Citations: View citations in EconPapers (18)

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Related works:
Chapter: Floats, Pegs and the Transmission of Fiscal Policy (2013)
Journal Article: Floats, Pegs and the Transmission of Fiscal Policy (2011)
Working Paper: Floats, Pegs and the Transmission of Fiscal Policy (2011)
Working Paper: Floats, pegs and the transmission of fiscal policy (2011)
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