Title: The Effects of Government Deficits on Equilibrium Real Exchange Rates and Stock Prices
Abstract: In order to study the effect of government budget deficits on equilibrium real exchange rates and stock prices I use a theoretical and an empirical approach. The theoretical part modifies a two-country cashin-advance model like used in Lucas(1982) and Sargent(1987). The government pursues exogenously specified targets for fiscal and monetary policies. The equilibrium real exchange rate is determined by supply and demand of each currency after trading goods and stock prices follow the CAPM model. The implied result is that unanticipated increases in government deficits raise expectations of future taxes and inflation and therefore are associated with real exchange rate devaluations and lower stock prices. This finding is strongly supported by the model empirical estimation for the small-economy case.
Publication Year: 2003
Publication Date: 2003-01-01
Language: en
Type: article
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