Linking Fiscal Policy and External Competitiveness in Sub-Saharan Africa – Does Government Spending Drive The Real Exchange Rate in Sub-Saharan Africa

Do government spending patterns and composition tell us anything about the behaviour of the real exchange rate in Sub-Saharan Africa? We develop a simple 2-sector small open economy model which shows that government spending and productivity differential are associated with the real exchange rate appreciation. Using a panel of Sub-Saharan Africa (SSA) countries, we perform a coordinated empirical analysis that overwhelmingly confirms the predictions of the model. Next, we disaggregate government spending into three major components - consumption, investment and transfer payments – and check whether the composition of government spending provides any insight into the dynamics of the real exchange rate in SSA. Our results suggest a yes. In particular, government consumption and transfer payments generate real appreciation, while government investment depreciates the real exchange rate. These findings are robust in magnitude and signed direction, but their effects are not always significant. We also show that the composition of government spending provides a good insight into the effects of government spending shocks in the short run, but the short and long run effects of fiscal shocks are in general not equivalen