ABSTRACT
A tax-financed increase in government expenditure leads to a reduction in private consumption and a depreciation of the exchange rate as domestic residents accumulate net foreign assets in order to finance the higher level of aggregate absorption. Despite a voluminous literature on the appropriate design and implementation of fiscal policy in economies which are open to international trade in commodities, services and financial assets, the issue remains controversial. With floating exchange rates, the bond financed fiscal expansion will appreciate the foreign exchange value of the domestic currency with the resulting loss in international competitiveness reducing net exports. It is constructive to consider the effects of a bond financed fiscal expansion in this model, in which the government raises its demand for non-traded goods. Simulation was performed by noting that a fiscal expansion which is not financed by raising taxes or by monetary expansion must be financed residually by issuing more debt.
