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Barcelona GSE Working Paper Series Working Paper nº 644Fiscal Foresight, Forecast Revisions and the Effects of Government Spending in the Open Economy

By  and Luca Gambetti and Luca Gambetti

Abstract

This paper investigates the effects of government spending on the real exchange rate and the trade balance in the US using a new VAR identification procedure based on spending forecast revisions. I find that the real exchange rate appreciates and the trade balance deteriorates after a government spending shock, although the effects are quantitatively small. The findings broadly match the theoretical predictions of the standard Mundell-Fleming model and differ substantially from those existing in literature. Differences are attributable to the fact that, because of fiscal foresight, the government spending is non-fundamental for the variables typically used in open economy VARs. Here, on the contrary, the estimated shock is fundamental. JEL classification: C32, E32, E62

Topics: VARs, fiscal policy, twin deficits, trade balance, Mundell-Fleming, forecast revisions, fiscal news, survey
Year: 2012
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