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Journal of Economic Integration 2011 March;26(1) :29-44.
Exchange-Rate Regimes and the Effectiveness of Fiscal Policy

Georgios Karras 

University of Illinois
Copyright ©2011 Journal of Economic Integration

How does the potency of fiscal policy depend on a country's exchange-rate regime? The Mundell-Fleming theoretical model predicts that fiscal policy can affect output under both fixed and flexible exchange rates, but that the effect is larger when the exchange rate is fixed. Using a panel data set of 61 countries for the 1951-2007 period, the paper shows that fiscal policy is indeed more potent under fixed exchange rates than under flexible, and that the difference is substantial: the estimated models imply that maintaining a fixed exchange rate raises the long-run fiscal multiplier by roughly a third.

JEL Classification E62, F41

Keywords: Fiscal Policy | Fixed or Flexible Exchange Rates
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