Fiscal policy, the real exchange rate, and traded goods

We estimate, for the US and other three OECD countries, the effects of government spending shocks on the CPI real exchange rate, the trade balance and their comovements with GDP and private consumption. We then decompose, via alternative methodologies, the (conditional) variations of the CPI real exchange rate into variations of (i) the traded goods real exchange rate, and (ii) the relative price of traded to non-traded goods. We reach three main conclusions. First, in all countries a rise in government spending induces a depreciation of the CPI real exchange rate and a trade balance deficit. In the US, however, the effect on the trade balance is small. Second, in all countries private consumption rises in response to a government spending shock, and therefore comoves positively with the real exchange rate. Third, both components of the CPI real exchange depreciate. The contribution of the relative price of non-traded goods is sizeable, and particularly so in the case in which traded goods prices are measured in terms of export and import prices. We argue that all these results stand in stark contrast with a baseline open-economy business cycle model augmented with non-traded goods.