Fiscal Policy and the Real Exchange Rate

Santanu Chatterjee () and Azer Mursagulov

No 2012/052, IMF Working Papers from International Monetary Fund

Abstract: Government spending on infrastructure has recently increased sharply in many emerging-market economies. This paper examines the mechanism through which public infrastructure spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral adjustment costs, we show that government spending generates a non-monotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-offs. The effect of government spending on the real exchange rate depends critically on (i) the composition of public spending, (ii) the underlying financing policy, (iii) the intensity of private capital in production, and (iv) the relative productivity of public infrastructure. In deriving these results, the model also identifies conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities, namely the intertemporal relationship between government spending, private consumption, and the real exchange rate.

Keywords: WP; government spending; exchange rate; Fiscal policy; public investment; consumption; real exchange rate; intersectoral adjustment costs; public capital; investment subsidy; shadow price; adjustment cost; government spending increase; dynamic adjustment; exchange rate dynamics; sensitivity to financing policy; shocks to variation; deviations from PPP; Balassa-Samuelson productivity effect; Real exchange rates; Public investment spending; Public investment and public-private partnerships (PPP); Global (search for similar items in EconPapers)
Pages: 40
Date: 2012-02-01
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Citations: View citations in EconPapers (5)

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Journal Article: FISCAL POLICY AND THE REAL EXCHANGE RATE (2016)
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