DP322 On Fiscal Policies, External Imbalances and Fundamental Equilibrium Exchange Rates

Author(s): George Alogoskoufis
Publication Date: June 1989
Keyword(s): Exchange Rates, Fiscal Policy, Inflation, Unemployment
JEL(s): 131, 321, 431
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=322

This paper presents an investigation of the relationship between fiscal policies, fundamental equilibrium real exchange rates and misalignments under fixed nominal exchange rate regimes like those proposed by McKinnon and supply-side fiscal policy. The medium-run effects operate mainly through the accumulation or decumulation of external assets. The analysis suggests that even temporary shifts in fiscal policy have permanent effects on fundamental equilibrium exchange rates and the natural rate of unemployment. In addition, because of differential inflation across countries, real exchange rates become misaligned in the short-run.