Marcos Mac Mullen from the Federal Reserve Board will present "Fiscal Policy, Portfolio Frictions, and International Transmission"

Abstract: I offer a unified explanation for two puzzles in international economics: (i) the tendency for fiscal expansions to depreciate the exchange rate and increase net trade, and (ii) the exchange rate disconnect — the near-random-walk behavior of exchange rates uncorrelated with macroeconomic fundamentals. I present new evidence showing that debt-financed US fiscal expansions lead to deviations from uncovered interest parity, favoring dollar-denominated assets, and increases in US gross foreign assets, contrary to predictions of standard models. I propose a model where portfolio rebalancing frictions drive the international transmission of debt-financed fiscal expansions and generate exchange rate dynamics consistent with the disconnect.