Fiscal Policy, Relocation of Firms, and the Exchange Rate

This study incorporates international firm mobility into a new open economy macroeconomic model to analyze the question of how allowing for the international relocation of firms affects the impact of government spending shock on consumption and exchange rate. The study shows that the government spending shock of a home country results in a proportionate decrease in the relative home consumption level and a depreciation of the home currency. In addition, depreciation increases (decreases) the relative real profits of firms located in the home country (abroad), and consequently, firms relocate to the home country. The study also shows that an increase in the degree of firm mobility weakens the effects of government spending shocks on relative consumption and exchange rate.