Fiscal policy under fixed exchange rates

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Fiscal policy under fixed exchange rates means the setting of government revenues (e.g. taxes, fees / contributions from public services) and government expenditures (e.g. government consumption expenditure, capital expenditure, subsidies) by the government when the external value of a currency is fixed. The fixed exchange rate means that the price of the domestic currency for the foreign currencies is fixed or may deviate from the agreed central rate within a narrow range at most. If there are deviations from this central rate in the foreign exchange market, the central bank mustintervene.

Alternative definition

The phrase "fiscal policy under fixed exchange rates" is a combination of two terms: " fiscal policy " and " fixed exchange rate ". All definitions in the literature can only be found separately, ie there is no separate definition for this group of words. The definitions given for the terms "fiscal policy" and "fixed exchange rate" usually only differ in terms of their synonyms . This should be made clear by the following example. Fiscal policy under fixed exchange rates states:

  • "the economic policy activities of the state", if the exchange rate "is fixed by institutional regulations at a certain level or within a certain range".
  • "All fiscal policy measures of the public sector in the service of economic policy by means of public revenues and expenditures", if the exchange rate is fixed "by the government or the central bank".

It should be noted that fiscal policy is part of fiscal policy. Financial policy is, in turn, an instrument of the state's economic policy. Basically, both terms amount to the same thing. The term "economic policy" is, however, broader than the term "financial policy".

The fixed exchange rate within a certain range is more realistic. In the case of persistent balance of payments deficits (or surpluses), countries can hardly avoid a devaluation (or revaluation ) in the long term. Because of this, the exchange rates are not completely fixed.

Term classification

Fiscal policy is an instrument of economic policy. Changes in economic policy affect the exchange rate. The following explains the impact a change in fiscal policy has on a fixed exchange rate. Since the exchange rate is fixed, fiscal policy cannot operate alone. In order to prevent an appreciation or depreciation, the central bank must also intervene with the help of monetary policy .

Expansive fiscal policy

Expansive fiscal policy means increasing government spending or reducing government revenue (e.g. reducing taxes).

With an expansive fiscal policy the goods market equilibrium is increased, ie that the state demand is increased. The result is higher levels of production and falling unemployment. This in turn results in a higher income, a higher price level and associated with an increase in the interest rate (expansionary fiscal policy induces a capital account surplus and a current account deficit ). When production expands, the demand for money increases (excess demand for money). If the price level rises, the domestic currency will appreciate. If the central bank did not intervene in the foreign exchange market , the exchange rate would fall due to an increase in the domestic interest rate. To prevent this, the central bank buys foreign assets for its own money. In the long term, the central bank will be forced to expand the money supply. This increases the money supply again. Falling interest rates and rising incomes reduce financial account surpluses and increase current account deficits. The exchange rate is unchanged after this intervention. In the new equilibrium, production has increased compared to the original state and the exchange rate has remained constant.

Result

With fixed exchange rates, fiscal policy is effective in the short and long term. The long-term income effect is more effective with an expansive fiscal policy than the short-term one when the capital flows react elastically to interest rates.

Capital real estate

Capital real estate

If there is a deficit in the balance of payments and payments, the expansionary fiscal policy (IS IS ') with fixed exchange rates and with international capital mobility (ZZ) causes a higher equilibrium income in the short term (WK 2 ). The money supply goes down (LM LM ") until the trade deficit is eliminated (WK 3 ). In the longer term, the central bank is forced to compensate for excess foreign exchange demand by selling foreign currency and thus collecting central bank money. This is followed by a crowding-out effect and an increase The interest rate due to the original expansionary fiscal policy and the shortage of the money supply. The demand for goods and the supply of money return to the initial level. In the longer term, private consumption and investments are displaced. As a result, the fiscal policy is ineffective here.

Capital mobility

Capital mobility

With an expansive fiscal policy (IS IS ') the interest rates (WK 2 ) rise , but inflowing capital from abroad ensures that the domestic interest rate remains at world level. The foreign capital is exchanged for domestic currency at the fixed exchange rate. This results in an increase in the money supply (LM LM "). As a result, expansionary fiscal policy with international capital mobility (ZZ) results in a high balance of payments equilibrium with unchanged interest rate (WK 3 ) due to high balance of payments surpluses with rapid and strong expansion of the money supply. The income effects are greater in the short and long term Here, the fiscal policy impulses are supported in monetary terms by the changes in the foreign exchange reserves. Fiscal policy achieves the greatest possible efficiency in influencing aggregated demand. The expansionary monetary policy cannot influence output and prices.

Adjustment of the exchange rate in the medium term

A country can specify an abrupt change in the value of the domestic currency into foreign currency.

Politically administered devaluation

  • Increase in the price of domestic currency in foreign currency by the central bank.

In the event of a devaluation, the fixed exchange rate rises and domestic goods become cheaper in relation to foreign goods and services. Production increases due to increased transactions and there is an excess demand for money. In order to counteract the resulting increase in the domestic interest rate, the central bank must intervene in the foreign exchange market. The purchase of foreign assets expands the money supply. Eventually there is an expansion of production, an increase in reserves and an expansion of the money supply. The increase in the central bank's currency reserves is offset by the inflow of private capital into the balance of payments. The government's reasons for a devaluation are the possibility of the state to counteract unemployment without monetary policy, the improvement of the current account by a devaluation of the currency and an increase of the currency reserves.

Politically administered revaluation

  • Reduction of the price of domestic currency in foreign currency by the central bank.

In the event of an appreciation, the fixed exchange rate level falls, so that domestic goods become more expensive in relation to foreign goods and services. Lower transactions lead to falling production and thus to an excess supply of money. As the domestic interest rate falls, the central bank has to intervene. It has to reduce the money supply by selling foreign assets. The appreciation leads to a reduction in production, a decrease in official reserves and a decrease in the money supply.

Reasons for a fixed exchange rate

  • In the short term, there is no real devaluation and overall economic decline in demand, but an increase in the money supply.
  • A devaluation also leads to an increase in overall economic demand and the money supply (an appreciation has the opposite effect).
  • In the long run, the expansionary fiscal policy causes a real appreciation of the exchange rate, an expansion of the money supply and a rise in the domestic price level.
  • The depreciation of the exchange rate leads to a proportional increase in the long-term money supply and price level.
  • The monetary adjustment does not result in an unfavorable change in the domestic interest rate or the exchange rate.

Reasons against a fixed exchange rate

  • The country is giving up an effective instrument (monetary policy) for correcting trade imbalances and influencing the economy.
  • The country is relinquishing control of the interest rate and has to track the movements of the interest rate abroad.

Individual evidence

  1. ↑ Cf. Gustav Dieckheuer: Macroeconomics: Theory and Politics . 3. Edition. Springer, Berlin Heidelberg New York 1998, pp. 44 and 310.
  2. ↑ See Gabler Verlag: Gabler Wirtschafts Lexikon . 15th edition. Vol. EJ, Gabler Verlag, Wiesbaden 2000, pp. 1069 and 1111.
  3. ↑ See Gabler Verlag: Gabler Wirtschafts Lexikon . 15th edition. Vol. EJ, Gabler Verlag, Wiesbaden 2000, p. 1069.
  4. ↑ See Paul R. Krugman, Maurice Obstfeld: Internationale Wirtschaft: Theory and Politics of Foreign Trade . 7th edition Pearson Studium, Munich 2006, p. 587 f.
  5. ^ Cf. Gerhard Schmitt-Rink, Dieter Bender: Macroeconomics of closed and open economies . 2nd edition Springer, Berlin Heidelberg New York Tokyo 1992, p. 213.
  6. ↑ a b cf. Gerhard Schmitt-Rink, Dieter Bender: Macroeconomics of closed and open economies . 2nd edition Springer, Berlin Heidelberg New York Tokyo 1992, p. 214.
  7. ↑ See Jeffrey D. Sachs, Felipe Larrain B .: Macroeconomics - In a global perspective . Oldenbourg, Munich Vienna 1995, p. 528.
  8. ↑ a b Cf. Jeffrey D. Sachs, Felipe Larrain B .: Macroeconomics - In a global view . Oldenbourg, Munich Vienna 1995, p. 527.
  9. ↑ a b c Cf. Paul R. Krugman, Maurice Obstfeld: International economy: theory and politics of foreign trade . 7th edition Pearson Studium, Munich 2006, p. 588.
  10. ↑ See Paul R. Krugman, Maurice Obstfeld: Internationale Wirtschaft: Theory and Politics of Foreign Trade . 7th edition Pearson Studium, Munich 2006, p. 588 f.
  11. ↑ a b c d Cf. Paul R. Krugman, Maurice Obstfeld: International economy: theory and politics of foreign trade . 7th edition Pearson Studium, Munich 2006, p. 607.
  12. ↑ a b Cf. Olivier Blanchard, Gerhard Illing: Macroeconomics . 3. Edition. Pearson Studium, Munich 2004, p. 595.

literature

  • Olivier Blanchard, Gerhard Illing: Macroeconomics. 3. Edition. Pearson Studium, Munich 2004, ISBN 3-8273-7051-5 .
  • Gustav Dieckheuer: Macroeconomics: Theory and Politics. 3. Edition. Springer, Berlin Heidelberg New York 1998, ISBN 3-540-63849-0 .
  • Gabler Verlag: Gabler Wirtschafts Lexikon. 15th edition. Bd. EJ, Business Management Publishing House Dr. Th. Gabler GmbH, Wiesbaden 2000, ISBN 3-409-32998-6 .
  • Paul R. Krugman, Maurice Obstfeld: International Economy: Theory and Politics of Foreign Trade. 7th edition Pearson Studium, Munich 2006, ISBN 3-8273-7199-6 .
  • Jeffrey D. Sachs, Felipe Larrain B .: Macroeconomics - In a global perspective. Oldenbourg, Munich Vienna 1995, ISBN 3-486-22709-2 .
  • Gerhard Schmitt-Rink, Dieter Bender: Macroeconomics of closed and open economies. 2nd edition Springer, Berlin Heidelberg New York Tokyo 1992, ISBN 3-540-55905-1 .

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