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Deflationary Adjustment Processes and the Effectiveness of Structural Reforms In Monetary Unions

George Demopoulos and Nicholas Yannacopoulos
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George Demopoulos: Athens University of Economics and Business, European Chair Jean Monnet
Nicholas Yannacopoulos: University of Piraeus

No 201602, Working Papers from Athens University Of Economics and Business, Department of Economics

Abstract: In a currency area,the only policy option available to a deficit country to regain the loss of its competitiveness is to deflate. This is going to be a painful process, especially in situations in which the Tobin-Fisher effect is dominant. Adjusting through deflation may destabilize (under certain conditions) the economy of the debtor country, while in cases in which stability is preserved , the economy is trapped in a deflationary equilibrium characterized by low output and employment. There are no policies, at the national level, able to help the economy of the debtor country out of this deflationary trap, if the surplus country insists on preserving its surpluses. In this case, the debtor is forced to reduce its spending , demand side policies are out of question, while supply policies are counterproductive. Deflation may also worsen the terms of trade of the debtor country, reducing further its welfare.

Keywords: Monetary unions; asymmetric adjustments; structural reforms (search for similar items in EconPapers)
JEL-codes: E52 E61 F15 F36 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2016-03
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