Discussion of “Fiscal Shocks and the Real Exchange Rate” by Agustin S. Bénétrix & Philp R. Lane Davide Furceri OECD, University of Palermo Banco de Espana Conference Interactions between monetary and fiscal policies Madrid, February 2010

Aim of the paper Estimate the impact of shocks to government spending on the real exchange rate for a panel of EMU member countries: The authors estimate a panel VAR for eleven EMU countries using a three- variable system (spending, output, real exchange rate); Differentiating among components of government spending: i) government consumption; i.a) non-wage component; 1.b) wage component; ii)government investment.

Main results A shock to government absorption (consumption + investment) appreciates the real exchange rate; Shocks to government investment have larger and more persistent effects than government consumption; Among government consumption the government wage component has larger effect than the non-wage one; The results are robust to several tests.

Major Comments The paper provides new interesting findings on the effect of spending shocks on the real exchange rate; It is very enjoyable to read…. …but at the same time more efforts could have been done to convince the reader about the robustness of the results and the appropriateness of the methodology additional analysis could test for non-linearity

Robustness test One of the (classical) comment is the appropriateness of the identification strategy. In particular, one could be skeptical about the absence of simultaneous response of government spending to output. To provide more convincing support two strategies could be adopted: 1) Perform an a analysis similar to Beetsma et al. (2006) using quarterly data. 2) Take out from government absorption those components that are more likely to act as automatic stabilizers (Derby and Melitz, 2009; Furceri, 2010).

Robustness test Although it is to be good to parsimonious (specially in VAR!) as robustness test the authors should include taxes in the set of variables, to indeed be sure about the correct identification of government spending shocks; Are we sure that the variables in the VAR are integrated of the same order? One could argue that this must be the case for the variables before the “difference” with respect to the EMU. To this purpose unit roots tests (preferably on the quarterly series) should be carried out.

Robustness test The construction of data in relative terms is based on differencing the variables with the respect to the EMU -j aggregate. Would this difference for large countries affect also the nominal exchange rate? Subdivide the analysis between small and large countries Construct the difference with respect to the EMU The authors claim that the real depreciation result found for non- EMU countries is due to different exchange rate regimes. To convince the reader, a similar test could have been done focusing on the EU before 1991.

Additional analysis It would be interested to see if the results differ between: Large vs. small countries Large trade weight vs. small trade weight High debt (refinancing ratio) vs. small debt countries EU sample before 1991

Minor points The authors assume that total expenditure is equal to government consumption + investment. In contrast, transfers are a considerable part of the total; As in the introduction, the discussion in the rest of the paper should focus more on the real exchange rate and downplay the discussion of the real output results. Are time fixed effects significant?

Thanks!

Fiscal Shocks and the Real Exchange Rate by Agustin S. Bénétrix & Philp R. Lane Discussion by: Davide Furceri OECD, University of Palermo Banco de Espana Conference Interactions between monetary and fiscal policies Madrid, February 2010