Fiscal Policy, Expectations, and Exchange-Rate Dynamics

Jay H Levin

Review of International Economics, 1994, vol. 2, issue 1, 50-61

Abstract: This paper uses the sticky-price monetary model to analyze the effects of fiscal policy on the exchange rate under alternative assumptions about exchange-rate expectations. The use of different expectations mechanisms--specifically the perfect-foresight model and the popular models tested by Frankel and Froot: regressive, adaptive, and distributed-lag--is based on recent empirical evidence suggesting that exchange-rate expectations may not be rational. The most surprising finding in the paper is that with adaptive and distributed-lag expectations, fiscal expansion has no initial impact on the exchange rate, and the same may be true for regressive expectations. Copyright 1994 by Blackwell Publishing Ltd.

Date: 1994
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