<p>The <strong>relationship between government expenditure and exchange rate</strong> is an important one. The key question in current policy and academic debates is What are the effects of fiscal policy on aggregate economic activity in a globalized world?</p>
<p>The central challenge in this debate is how to identify fiscal shocks in the data. <a href="https://www.nber.org/papers/w21100" rel="nofollow noreferrer">Auerbach and Gorodnichenko (2015)</a> address this challenge by using daily data on US government spending. Exploiting this high-frequency data, they find that <strong>unexpected government spending instantly affects exchange rates and the dollar appreciate</strong>, which if I understand correctly supports your intuition.</p>
<p>The direction of the response of the exchange rate is consistent with basic macroeconomic theory; in an economy with a flexible exchange rate, government spending shocks should lead to appreciation of the domestic currency.</p>

CC BY-SA 4.0
2020-04-01T12:56:10.687Z
2020-08-19T21:49:58.103Z
2020-08-19T21:49:58.103Z
emeryville
<p>I've read an increase in government expenditure can lead to increase the chances of currency crisis but shouldn't it lead to the opposite?</p>
<p>Fiscal deficit ----&gt; Govt will undertake borrowings ---&gt; crowding out -----&gt; interest rates will rise ----&gt; capital inflows -----&gt; rise in forex/international reserves</p>
<p>what is wrong with my reasoning/logic?</p>

<currency><foreign-exchange>
Relationship between government expenditure and exchange rate?
Varun Singh
# Relationship between government expenditure and exchange rate?

(Asked by: username_0 on 2020-03-18)

I've read an increase in government expenditure can lead to increase the chances of currency crisis but shouldn't it lead to the opposite?

Fiscal deficit ----> Govt will undertake borrowings ---> crowding out -----> interest rates will rise ----> capital inflows -----> rise in forex/international reserves

what is wrong with my reasoning/logic?

**Tags:** currency, foreign-exchange


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## 1 answers

### Answer by username_1 on 2020-04-01. Score: 1

The **relationship between government expenditure and exchange rate** is an important one. The key question in current policy and academic debates is What are the effects of fiscal policy on aggregate economic activity in a globalized world?

The central challenge in this debate is how to identify fiscal shocks in the data. [Auerbach and Gorodnichenko (2015)](https://www.nber.org/papers/w21100) address this challenge by using daily data on US government spending. Exploiting this high-frequency data, they find that **unexpected government spending instantly affects exchange rates and the dollar appreciate**, which if I understand correctly supports your intuition.

The direction of the response of the exchange rate is consistent with basic macroeconomic theory; in an economy with a flexible exchange rate, government spending shocks should lead to appreciation of the domestic currency.


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