Government spending and the exchange rate: Exploring this relationship in Mexico using a cointegrated system of equations

Moritz Cruz and Armando Sánchez‐Vargas

Review of Development Economics, 2022, vol. 26, issue 1, 587-605

Abstract: The main aim of this paper is to empirically test the effect of both public consumption and investment on the exchange rate in the Mexican economy. Recent increasing literature on the topic has pointed out that effects in either direction of disaggregated public expenditure on the exchange rate can be expected. Therefore, we investigate this using a system of cointegrated equations. The simulations’ results suggest that expansions of government consumption leave unchanged the real exchange rate and depreciate the nominal one; on the contrary, government investment also produces a nominal depreciation, and only large shocks produce small real appreciations. These movements of the exchange rate are in any case negligible. At the economic policy level, the results support the use of fiscal policy to achieve growth and developmental goals.

Date: 2022
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