Fiscal Consolidations under Fixed Exchange Rates

Paola Casell ()
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Paola Casell: Banca d'Italia

No 336, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We present the “fixed exchange rate” version of the Obstfeld and Rogoff model and analyze the international transmission of fiscal policy shocks. It is shown that the welfare effects of an unanticipated contraction in government expenditure in the home country crucially depend on the way in which world money stock is set. If home authorities alone are responsible for pegging the exchange rate, a fiscal adjustment induces a decrease in the real interest rate, stimulates private consumption and limits the contraction in world output, compared with a situation in which a cooperative scheme is implemented. The model is then used to propose a new interpretation of recent events in the EU countries that have enacted restrictive fiscal policies while pegging their currencies to the DM.

Keywords: exchange rate; social welfare; fiscal policy (search for similar items in EconPapers)
JEL-codes: E62 F31 H30 (search for similar items in EconPapers)
Date: 1998-10
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_336_98

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