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Barcelona GSE Working Paper No. 644

Title: Fiscal Foresight, Forecast Revisions and the Effects of Government Spending in the Open Economy
Authors: Luca Gambetti
Date: 25-06-2012
Keywords: VARs, fiscal policy, twin de ficits, trade balance, Mundell-Fleming, forecast revisions, fiscal news, survey of professional forecasters
JEL Codes: C32, E32, E62
This paper investigates the effects of government spending on the real exchange rate and the trade balance in the US using a new VAR identification procedure based on spending forecast revisions. I find that the real exchange rate appreciates and the trade balance deteriorates after a government spending shock, although the effects are quantitatively small. The findings broadly match the theoretical predictions of the standard Mundell-Fleming model and differ substantially from those existing in literature. Differences are attributable to the fact that, because of fiscal foresight, the government spending is non-fundamental for the variables typically used in open economy VARs. Here, on the contrary, the estimated shock is fundamental.
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