Floats, pegs and the transmission of fiscal policy

Giancarlo Corsetti, Müller, Gernot and Keith Kuester
Authors registered in the RePEc Author Service: Gernot J. Müller

No 8180, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: According to conventional wisdom, fiscal policy is more effective under a fixed than under a flexible exchange rate regime. In this paper we 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. We derive an analytical characterization of the transmission mechanism of expansionary spending policies under a peg, showing that the long-term real interest rate necessarily rises if inflation rises on impact, in response to an increase in government spending. This 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: Exchange rate regimes; Fiscal policy; Long-term rates; Monetary policy; New-keynesian models (search for similar items in EconPapers)
JEL-codes: F41 F42 F43 (search for similar items in EconPapers)
Date: 2011-01
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Citations: View citations in EconPapers (46)

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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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