Fiscal Policy, the Real Exchange Rate and Traded Goods

We estimate the effects of government spending shocks on the CPI real exchange rate, the trade balance and their co‐movements with GDP and private consumption. We decompose the variations of the CPI real exchange rate into variations of the traded goods real exchange rate and the relative price of traded to non‐traded goods. We reach three main conclusions: a rise in government spending induces a depreciation of the CPI real exchange rate and a trade balance deficit; private consumption rises in response to a government spending shock and therefore co‐moves positively with the real exchange rate; both components of the CPI real exchange depreciate.