THE EFFECTS OF FISCAL SHOCKS ON THE EXCHANGE RATE IN THE EMU AND DIFFERENCES WITH THE US

-Francisco de Castro and Daniel Garro (2012)

• The author assess the effects of government spending shocks on the REER and on net exports in the Euro Area as a whole.
• Then, compared the above effects with those observed in the US and provide a potential explanation for the discrepancies
between the two geographical areas.
• In this paper Euro Area has been considerd as a single entity, while the other papers conduct panel analyses which ascertain
average responses across the countries considered. In practice, a panel analysis implies that intra-EU trade linkages have not been
netted out.
• Previous research has used annual data, whereas authors have looked for quarterly figures.
• Annual data make some identifying assumptions more controversial, especially the assumption that fiscal variables do not react
contemporaneously to other variables in the system.
• Findings: REER appreciates in response to government expenditure shocks in the EMU, the opposite happens in the US.
• In order explain these disparities, author analysed the reaction of the NEER to spending shocks in both areas, the role of the
uncovered interest parity condition and the cyclical behavior of government spending shocks. Due to data availability for the Euro
Area, focued on the sample 1981-2007.
• Govt expenditure increases bring about REER appreciations and higher budgetary primary and external deficits, in line with the
"twin deficits“ hypothesis.
• Likewise, the discrepancies observed in the reaction of the REER between the Euro Area and the US are related to the dissimilar
reaction of short-term nominal interest rate spreads, which is ultimately attributed to the concurrence of three factors in the US:
• 3 FACTORS: Its leading role in the world business cycle, the role of "safe haven" currency of the US dollar and the countercyclical
behaviour of government spending shocks.
 Fiscal Shocks and The Real Exchange Rate
-Agust´ın S. Ben`etrix ´Philip R. Lane (feb 2009)

• Authors estimate the impact of shocks to government spending on the real exchange rate
for a panel of EMU member countries.
• Key findings: The impact differs across different types of government spending, with
shocks to public investment generating a larger and more persistent impact on the real
exchange rate than shocks to government consumption
• Methodology: A panel VAR for eleven EMU countries in order to analyse the relation
between government spending and real exchange rate.
I. Estimates a more parsimonious three-variable system (government spending, output
and the real exchange rate).
II. The impact of government spending may differ across its components. Accordingly,
allowed public investment to operate differently to government consumption.
III. The impact of shocks to the wage component of government consumption is larger
than for shocks to the non wage component.
IV. These results carry over to different measures of the real exchange rate and to the
relative price of nontradables.