Fiscal Devaluations

Emmanuel Farhi, Gita Gopinath and Oleg Itskhoki

No 8721, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We show that even when the exchange rate cannot be devalued, a small set of conventional fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a standard New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions -- producer or local currency pricing, along with nominal wage stickiness; under alternative asset market structures, and for anticipated and unanticipated devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation -- one, a uniform increase in import tariff and export subsidy, and two, a value-added tax increase and a uniform payroll tax reduction. When the devaluations are anticipated, these policies need to be supplemented with a consumption tax reduction and an income tax increase. These policies have zero impact on fiscal revenues. In certain cases equivalence requires, in addition, a partial default on foreign bond holders. We discuss the issues of implementation of these policies, in particular, under the circumstances of a currency union.

Keywords: Competitive devaluation; Fiscal policy; Currency union (search for similar items in EconPapers)
JEL-codes: E32 E6 F3 (search for similar items in EconPapers)
Date: 2011-12
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Related works:
Journal Article: Fiscal Devaluations (2014)
Working Paper: Fiscal Devaluations (2014)
Working Paper: Fiscal devaluations (2012)
Working Paper: Fiscal devaluations (2012)
Working Paper: Fiscal Devaluations (2011)
Working Paper: Fiscal Devaluations (2011)
Working Paper: Fiscal Devaluations
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