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Questioning the puzzle: Fiscal policy, exchange rate and inflation

Author

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  • Laurent Ferrara
  • Luca Metelli
  • Filippo Natoli
  • Daniele Siena

Abstract

The paper re-investigates the effects of government spending shocks on the real exchange rate and inflation. In contrast with some previous puzzling results, we find that an increase in government spending appreciates the real exchange rate and is inflationary; besides, it induces a trade balance deficit and a decrease in consumption. The discrepancy with the existing literature lies in the identification of fiscal shocks: embedding a narrative approach in a proxy-SVAR is what makes the difference. Empirical findings are then well explained by a standard estimated open real business cycle model.

Suggested Citation

  • Laurent Ferrara & Luca Metelli & Filippo Natoli & Daniele Siena, 2020. "Questioning the puzzle: Fiscal policy, exchange rate and inflation," Working papers 752, Banque de France.
    • Handle: RePEc:bfr:banfra:752
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    More about this item

    Keywords

    : Fiscal Shocks; Real Exchange Rate; Inflation; Proxy SVAR; Narrative Shocks.;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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