Fiscal Policy, Relative Prices and Net Exports in a Currency Union

This paper studies the effects of fiscal policy on net exports, the terms of trade and expenditure switching. Using data on government spending and consumption taxes for twelve euro area countries over 1996 to 2018, it shows that fiscal austerity shocks improve net exports. This improvement in the trade balance is driven by falling imports while exports do not respond; export and import prices co-move and the terms of trade does not deteriorate in response to an austere shock. The empirical evidence confirms asymmetric expenditure switching, as domestic consumers switch towards domestically produced goods while foreign consumers fail to do so. In a second step, we rationalize these findings in a multi-product small-open DSGE model that features GHH preferences, a non-traded consumption good and pricing to market.