Born, Benjamin D'Ascanio, Francesco Müller, Gernot J. Pfeifer, Johannes
Year of Publication:
ifo Working Paper No. 352
In economies with fixed exchange rates, the adjustment to government spending shocks is asymmetric. A fiscal expansion appreciates the real exchange rate but does not stimulate output. A fiscal contraction does not alter the exchange rate, but lowers output. We develop these insights in a two-sector model of a small open economy with downward nominal wage rigidity. We establish new empirical evidence that supports the predictions of the model along several dimensions: not only does the exchange rate regime shape the fiscal transmission mechanism as predicted by the model - in doing so it also interacts with economic slack and inflation.
Downward nominal wage rigidity government spending shocks exchangerate peg real exchange rate nonlinear effects asymmetric adjustment depreciation bias