Type: Working Paper
Floats, pegs and the transmission of fiscal policy
Working Paper, Philadelphia : Federal Reserve Bank of Philadelphia, 2011FRB Working Paper, 2011/09
CORSETTI, Giancarlo, KUESTER, Keith, MÜLLER, Gernot J., Floats, pegs and the transmission of fiscal policy, Philadelphia : Federal Reserve Bank of Philadelphia, 2011FRB Working Paper, 2011/09 - https://hdl.handle.net/1814/36478
Retrieved from Cadmus, EUI Research Repository
According to conventional wisdom, fiscal policy is more effective under a fixed than under a flexible exchange rate regime. In this paper the authors 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. The authors derive an analytical characterization of the transmission mechanism of expansionary spending policies under a peg, showing that the long-term real interest rate always rises in response to an increase in government spending if inflation rises initially. This response 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.
Cadmus permanent link: https://hdl.handle.net/1814/36478
Full-text via DOI: 10.2139/ssrn.1767414
Series/Number: FRB Working Paper; 2011/09
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