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Fiscal devaluation and relative prices: evidence from the Euro area

Giampaolo Arachi () and Debora Assisi ()
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Giampaolo Arachi: Università del Salento
Debora Assisi: Università del Salento

International Tax and Public Finance, 2021, vol. 28, issue 3, No 8, 685-716

Abstract: Abstract The theoretical literature has long recognized that a fiscal devaluation, brought about by a budget-neutral shift from social security contributions towards value added tax (V-FD), could improve price competitiveness and help restore trade imbalances, especially for countries that cannot devaluate their currency. This paper provides evidence on the effects of a fiscal devaluation on the real effective exchange rate, the terms of trade and net exports. We focus on countries that joined the Euro Area in 1999 for which fiscal devaluation is a salient issue. We find that the responses are highly heterogeneous across countries and, on average, the estimates provide only a weak support to the theoretical predictions that a fiscal devaluation could affect the real effective exchange rate and the terms of trade. Consistently, we also find negligible results on the trade balance. We conclude that the potential of a V-FD should not be overemphasized, since its effects are rather limited on both relative prices and quantities.

Keywords: Fiscal devaluation; Exchange rate; Terms of trade; Internal competitiveness (search for similar items in EconPapers)
JEL-codes: E62 F45 H87 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10797-020-09623-4

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