Working Paper: CEPR ID: DP6903
Authors: Vahagn A. Galstyan; Philip R. Lane
Abstract: We show that the composition of government spending influences the long-run behaviour of the real exchange rate. We develop a two-sector small open economy model in which an increase in government consumption is associated with real appreciation, while an increase in government investment may generate real depreciation. Our empirical work confirms that government consumption and government investment have differential effects on the real exchange rate and the relative price of nontradables.
Keywords: government consumption; government investment; real exchange rate
JEL Codes: E62; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government Consumption (H59) | Real Appreciation (Y60) |
| Government Investment (H54) | Real Exchange Rate (F31) |
| Government Consumption (H59) | Relative Price of Nontradables (F16) |
| Relative Price of Nontradables (F16) | Real Appreciation (Y60) |
| Government Investment (H54) | Real Depreciation (D25) |