Abstract:

We propose a comprehensive general-equilibrium model for the determination of the nominal and real exchange rates and the analysis of their effects on real macro aggregates, under different monetary-fiscal policy interactions. When the monetary authority implements a floating exchange-rate regime—controlling inflation only—and the fiscal authority stabilizes debt, the nominal and real exchange rates are primarily determined by international financial shocks, generating a disconnect between exchange rates and real macro aggregates. When the monetary authority implements a peg exchange-rate regime—targeting the nominal exchange rate—and the fiscal authority stabilizes debt, the real exchange rate is primarily determined by TFP shocks, having it a residual role in affecting real macro aggregates. However, when the monetary authority accommodates unfunded deficits by the fiscal authority—causing high inflation—the nominal and real exchanges rates are determined by fiscal shocks, which also affects real macro aggregates. When calibrated to the data, our model is able to replicate the dynamics of the nominal and real macro aggregates for the Brazilian economy, which experienced all the different monetary-fiscal policy interactions over the 1980-2019 period.