Government Purchases and the Real Exchange Rate
Robert Kollmann ()
No 7427, CEPR Discussion Papers from C.E.P.R. Discussion Papers
Recent empirical research documents that an exogenous rise in government purchases in a given country triggers a persistent depreciation of its real exchange rate - which raises an important puzzle, as standard macro models predict an appreciation of the real exchange rate. This paper presents a simple model with limited international risk sharing that can account for the empirical real exchange rate response. When faced with a country-specific rise in government purchases, local households experience a negative wealth effect; they thus work harder, and domestic output increases. Under balanced trade (financial autarky) this supply-side effect is so strong that the terms of trade worsen, and the real exchange rate depreciates. In a bonds-only economy, an increase in government purchases triggers a real exchange rate depreciation, if the rise in government purchases is sufficiently persistent and/or labor supply is highly elastic.
Keywords: government purchases; limited international risk sharing; real exchange rate (search for similar items in EconPapers)
JEL-codes: E62 F36 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-opm
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Journal Article: Government Purchases and the Real Exchange Rate (2010)
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