Asymmetric Effect of Argentina?s Fiscal Deficit on the Real Exchange Rate

CHICAGO

Congreso; ANUAL MEETING AMERICAN ECONOMIC ASSOCIATION; 2020

AMERICAN ECONOMIC ASSOCIATION

3AbstractIt is well documented that fiscal deficits generate deterioration in real exchange rates. However, the composition of the fiscal deficit, whether generated by an increase in expenditure or a tax reduction, may generate asymmetric effects. In this article, the differential impact on the real exchange rate, generated by an increase in public consumption expenditure, public investment and tax reduction, is analyzed and quantified. To this end, we develop a dynamic stochastic general equilibrium model (DSGE) with government and external sector, which we calibrate and simulate for Argentina. We find that the fiscal deficit originated in tax reduction can improve the real exchange rate, whereas the one generated by any increase in expenditure deteriorates it. Furthermore, the deterioration in the real exchange rate is greater when public expenditure is destined to public consumption than when it is used for public investment. Quantifying these different effects on the exchange rate within a dynamic stochastic general equilibrium framework is an important exercise of political economy for highly dollarized emerging economies that exhibit higher inflation pass-through.