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The effects of government spending shocks on real exchange rate in Ethiopia

Hiluf Techane Gidey (Economics, College of Business and Economics, Adigrat University, Adigrat, Ethiopia)
Naser Yenus Nuru (Economics, College of Business and Economics, Adigrat University, Adigrat, Ethiopia)

Journal of Economic and Administrative Sciences

ISSN: 1026-4116

Article publication date: 1 April 2021

Issue publication date: 1 December 2022

193

Abstract

Purpose

Government spending has inconclusive effect on real exchange rate. From the very beginning neoclassical economists argued that a rise in government spending brings depreciation in real exchange rate while neo-Keynesians claimed that government spending appreciates real exchange rate. Hence, the main purpose of this paper is to examine the effect of government spending shock and its components' shocks, namely government consumption and government investment on real exchange rate over the period 2001Q1–2016Q1 for Ethiopia.

Design/methodology/approach

To examine the effects of government spending shocks on real exchange rate, Jordà's (2005) local projection method is employed in this study. The exogenous shocks, however, are identified recursively in a vector autoregressive model.

Findings

The impulse responses show that government spending shock leads to a statistically significant appreciation of real exchange rate in Ethiopia. This evidence supports the neo-Keynesian school of thought who predicts an appreciation of real exchange rate from a rise in government spending. While government investment shock depreciates real exchange rate on impact insignificantly, government consumption shock appreciates real exchange rate in this small open economy.

Originality/value

This research contributes to the scarce literature on the effect of fiscal policy shock on real exchange rate in small open economies like Ethiopia.

Keywords

Citation

Gidey, H.T. and Nuru, N.Y. (2022), "The effects of government spending shocks on real exchange rate in Ethiopia", Journal of Economic and Administrative Sciences, Vol. 38 No. 4, pp. 544-561. https://doi.org/10.1108/JEAS-07-2020-0137

Publisher

:

Emerald Publishing Limited

Copyright © 2021, Emerald Publishing Limited

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