Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2013-01-07
Revision-Date: 2013-01-09
Number: 13-212/VI
Author-Name: Dennis Bonam
Author-Workplace-Name: VU University Amsterdam, the Netherlands
Author-Name: Jasper Lukkezen
Author-Workplace-Name: Utrecht University, Utrecht, and CPB Netherlands Bureau for Economic Policy Analysis, the Netherlands
Title: Government Spending Shocks, Sovereign Risk and the Exchange Rate Regime
Abstract: Keynesian theory predicts output responses upon a fiscal expansion in a small open economy to be larger under fixed than floating exchange rates. We analyse the effects of fiscal expansions using a New Keynesian model and find that the reverse holds in the presence of sovereign default risk. By raising sovereign risk, a fiscal expansion worsens private credit conditions and reduces consumption; these adverse effects are offset by an exchange rate depreciation and a rise in exports under a float, yet not under a peg. We find that output responses can even be negative when exchange rates are held fixed, suggesting the possibility of expansionary fiscal consolidations.
Classification-JEL: E32, E52, E62
Keywords: Fiscal policy, government spending, exchange rate regime, sovereign risk, New Keynesian model, expansionary fiscal consolidation
File-Url: https://papers.tinbergen.nl/13212.pdf
File-Format: application/pdf
File-Size: 916343 bytes
Handle: RePEc:tin:wpaper:20130212