Macroeconomic Studies on Fiscal Policy and Real Exchange Rates

Abstract: This thesis contains four empirical macroeconomic studies and the papers may briefly be summarized as follows. In the first paper, we use both descriptive statistics and regression analysis to investigate whether movements in real exchange rates and money supply before and during fiscal contractions matter for the macroeconomic outcome. First we define fiscal contraction. Second, we label the contractions as successes, partial successes or failures depending on the macroeconomic outcome. Third, we confront the three categories with data on real exchange rate and money supply movements and find that preceding real depreciations are significantly larger for contractions having a favorable macroeconomic outcome. In the econometric analysis, we estimate a structural consumption function and find that private consumption growth is higher during contractions preceded by real depreciations compared to contractions preceded by real appreciations. In the second paper, we investigate whether private consumption growth is higher (lower) during periods of fiscal contractions (expansions). We make use of a structural consumption function that controls for the direct effects of e.g. fiscal policy, we focus on the expectational effects of fiscal actions. Contrary to some case studies, the results of our panel data imply that private consumption growth is lower during periods of contractions. We also check the sensitivity of the mentioned result by examining the effects of the composition, the size, and the preceding level and growth of the debt ratio. None of these factors alter the main findings, however. In the third paper we estimate a so-called common trends model of federal taxes and spending in the U.S. We find that the two variables are cointegrated and the common trends model is hence driven by one permanent and one temporary shock. The permanent shock is interpreted as being induced by structural policy decisions, while the temporary shock is of business cycle nature. We assign the permanent economic policy shocks and the business cycle shocks to Democratic and Republican terms. We find that Republicans are responsible for the major attempts to permanently decrease the size of the public sector - especially during the first half of the term - and that Democrats have been in office during most of the positive business cycle shocks. In the fourth paper, we examine the relative importance of permanent and transitory shocks for explaining movements in the real exchange rate of Japan and Sweden. Recent theoretical models suggest that transitory shocks are important both in the short and medium run due to imperfect competition and price stickiness. We estimate a common trends model including the real exchange rate and TFPs of Japan and Sweden. These variables are found to be cointegrated and the model is hence driven by two permanent shocks and one temporary shock. The results imply that, contrary to recent theoretical models, only a minor share (7.2% at most) of the forecast error variance decomposition is explained by the transitory shock. Hence, permanent (productivity) shocks clearly dominate the picture.