The pattern of government expenditure and the real exchange rate in a small open economy

Date of Award




Degree Name

Doctor of Philosophy (Ph.D.)



First Committee Member

Michael Connolly - Committee Chair


Since 1974, the variance of the real exchange rate in both developing and developed countries has increased substantially. Recently, this phenomenon has received considerable attention in the literature due to its relevance for stabilization policy. This dissertation examines the relationship between fiscal policy and the real exchange rate in the context of a small open economy. Two models are developed, both of which focus on the real side of the economy by ignoring the role of the money supply. The static one-period model assumes a balanced budget, while the two-period model allows us to distinguish between tax-financed and bond-financed government deficits, as well as between temporary and permanent changes in government spending.A change in fiscal policy affects the real exchange rate through its influnce on the level and composition of national spending as well as on the level and composition of wealth. The main result is that a rise in government expenditure financed by increased taxes appreciates the real exchange rate if the public sector has a higher propensity to spend on non-traded goods than the private sector.Empirically, we examine two issues. The first compares the pattern of government expenditure to that of the private sector. This is accomplished by estimating the elasticity of the real exchange rate and the elasticity of imports with respect to government and private spending. Second, we examine how fiscal policy, monetary policy and changes in the external terms of trade affect the real exchange rate.


Economics, General

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