Journal
EMPIRICAL ECONOMICS
Volume 49, Issue 4, Pages 1341-1365Publisher
PHYSICA-VERLAG GMBH & CO
DOI: 10.1007/s00181-015-0925-z
Keywords
Euro Area; SVAR; Fiscal shocks; Effective exchange rates; Relative prices; Twin deficits; Fiscal multipliers
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We analyse the impact of government spending shocks on the real effective exchange rate and net exports in the Euro Area within a standard structural VAR framework. We show that higher government spending leads to real exchange rate appreciation and to a fall in net exports, jointly with lower primary budgetary surpluses, in line with the twin deficits hypothesis. Our results are consistent both with the home-bias hypothesis of public expenditure and with public investment contributing to generating relative productivity gains in the traded goods sector. Contrary to what is observed in the Euro Area, the real effective exchange rate depreciates in the USA in response to higher government spending. Such different behaviour is attributed to two factors, namely the leading role of the US dollar as a safe haven currency and the countercyclical behaviour of discretionary government spending in the USA.
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