Fiscal policy and macroeconomic fluctuations in a fixed exchange rate regime

Abstract

This paper develops a model with imperfect competition and micro-foundation based on the framework of New Open Economy Macroeconomics in order to discuss government spending shock on macroeconomic fluctuations (for example, consumption, output, price, and terms of trade, etc.) under the fixed exchange rate regime and try to explain the role of consumption home bias. By way of theoretical derivation and simulation analysis, this paper discovers that without consideration of consumption home bias under the fixed exchange rate regime in the long term, government spending is positively related to domestic output but is negatively related to private sector consumption, price and terms of trade. Once you take consumption home bias into consideration like that consumers in two countries both are in favor of home goods, the relationship among government spending, consumption, output, and price will be reversed. And, in the short term government spending only will have an influence on interest rate and both of them are positive correlative.