Fiscal Shocks, the Trade Balance, and the Exchange Rate

Departmental Working Papers from Department of Economics, Louisiana State University

Abstract: This paper investigates empirically, using a VAR model, the response of the exchange rate and the trade balance to fiscal policy shocks for the U.S. economy during the period 1981:3-2006:3. The results indicate that positive shocks to real government purchases generate a persistent increase in the budget deficit, a transitory expansionary effect on output, and a long-lived positive effect on the price level, but reduce the real interest rate. Simultaneously, and consistent with interest parity, the real exchange rate depreciates, and the trade balance improves. Negative shocks to net taxes also generate a persistent increase in the budget deficit, and the effects on the model variables are generally in the same direction, but are almost never significant. Our results indicate it is inappropriate to attribute rising trade balance deficits to expansionary fiscal policy shocks, even though these shocks generate long-lived increases in the budget deficit.

Date: 2007-05
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-int, nep-mac and nep-pbe
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Working Paper: Fiscal Shocks, the Trade Balance, and the Exchange Rate (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:lsu:lsuwpp:2007-05

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