DP8986 Exchange rate regimes and fiscal multipliers

Author(s): Benjamin Born, Falko Juessen, Gernot Müller
Publication Date: May 2012
Keyword(s): exchange rate regimes, fiscal multiplier, fiscal policy, monetary policy, New Keynesian model, Panel VAR
JEL(s): E62, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8986

Does the fiscal multiplier depend on the exchange rate regime and, if so, how strongly? To address this question, we first estimate a panel vector autoregression (VAR) model on time-series data for OECD countries. We identify the effects of unanticipated government spending shocks in countries with fixed and floating exchange rates, while controlling for anticipated changes in government spending. In a second step, we interpret the evidence through the lens of a New Keynesian small open economy model. Three results stand out. First, while government spending multipliers are larger under fixed exchange rate regimes, the difference relative to floating exchange rates is smaller than what traditional Mundell-Fleming analysis suggests. Second, there is little evidence for the specific transmission channel which is at the heart of the Mundell-Fleming model. Third, the New Keynesian model provides a satisfactory account of the evidence.