An essay on the effects of government deficits on equilibrium real exchange rates and stock prices.

다국어 초록 (Multilingual Abstract)

The thesis goal is to investigate effects of government budget deficits on equilibrium real exchange rates and stock prices. In order to study this effect I use both a theoretical and an empirical approach. The theoretical part modifies a two-country cash-in-advance model like in Lucas(1982) and Sargent(1987). The government pursues exogenously specified targets for fiscal and monetary policies and there is an exchange rate market in the end of the day. The implied result is that since government deficits raise expectations of future taxes and inflation, they are associated with real exchange rate devaluations and lower stock prices. This finding is strongly supported by empirical evidence for a selected group of 19 countries, which respond for 76% of the World production. Panel data regressions allow for some quantitative results. An increase of the government deficit by 1% of the GDP is associated with an approximate devaluation of the real exchange rate of 1.5% for high-income economies and 2% for Latin America economies. For stock prices, the 1% GDP increase in the government deficit accompanies a fall in stock prices, in real terms, in the order of 2.8% for high-income economies and 10.2% for middle-income economies.