Working Paper: NBER ID: w1577
Authors: Michael Mussa
Abstract: This paper develops a dynamic, rational expectations model that generalizes both the standard, two-country, two-commodity model of real trade theory and the "dependent economy" model of open economy macroeconomics. This model is used to show how a variety of government policies can affect the real exchange rate (defined as the relative price of domestic goods in terms of foreign goods) and thereby replicate some of the effects of commercial policy. The policies considered include temporary and expected future shifts in the distribution of government spending, temporary general tax reductions financed by the issuance of government debt, controls on international capital movements, and policies that combine a fixed path of the nominal exchange rate and a fixed path of the nominal money supply (supported by sterilized official intervention in the foreign exchange market).
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JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending shifts (E62) | real exchange rate (F31) |
| tariffs on imports (F13) | relative price of domestic goods (P22) |
| capital controls (F38) | responsiveness of the real exchange rate (F31) |
| increase in government spending on domestic goods (H56) | appreciation of the real exchange rate (F31) |
| temporary fiscal expansion financed by government debt (E62) | initial appreciation of the real exchange rate (F31) |
| temporary fiscal expansion financed by government debt (E62) | current account surplus (F32) |
| temporary fiscal expansion financed by government debt (E62) | depresses the real exchange rate in the long run (F31) |
| capital controls (F38) | alter permissible difference between income and spending (D10) |
| fixed nominal money supply and exchange rate (F33) | influence the real exchange rate (F31) |