The Worst of Both Worlds: Fiscal Policy and Fixed Exchange Rates

Benjamin Born, Francesco D'Ascanio, Gernot Müller and Johannes Pfeifer

No 7922, CESifo Working Paper Series from CESifo

Abstract: Under fixed exchange rates, fiscal policy is an effective tool. According to classical views because it impacts the real exchange rate, according to Keynesian views because it impacts output. Both views have merit because the effects of government spending are asymmetric. A spending cut lowers output but does not alter the real exchange rate. A spending increase appreciates the exchange rate but does not alter output unless there is economic slack. We establish these results in a small open economy model with downward nominal wage rigidity and provide empirical evidence on the basis of quarterly time-series data for 38 countries.

Keywords: downward nominal wage rigidity; government spending shocks; exchange rate peg; real exchange rate; output; non-linear effects; asymmetric adjustment (search for similar items in EconPapers)
JEL-codes: E62 F41 F44 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_7922

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