A note on fiscal policy, investment location decisions, and exchange rates

Abstract

The paper argues that trade balances and exchange rates may be quite responsive to changes in the relative attractiveness of locating production facilities or storing other ‘taxable’ forms of wealth in different countries. This suggests that there are at least three important channels through which fiscal policy changes may be transmitted to exchange rates. It is argued that a country-oriented analysis of asset choice, as distinct from the traditional currency-oriented portfolio balance framework, may be important for understanding the behavior of exchange rates.