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Fiscal Devaluations

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  • Emmanuel Farhi
  • Gita Gopinath
  • Oleg Itskhoki

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 dynamic New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions– producer or local currency pricing, along with nominal wage stickiness; under arbitrary degrees of asset market completeness and for general stochastic sequences of 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 are revenue neutral. 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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17662.

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Date of creation: Dec 2011
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Publication status: published as “Fiscal Devaluations” (with Gita Gopinath and Oleg Itskhoki) Review of Economic Studies, forthcoming.
Handle: RePEc:nbr:nberwo:17662

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  1. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal Fiscal and Monetary Policy: Equivalence Results," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 141-170, 02.
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  13. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege," CEPR Discussion Papers 5220, C.E.P.R. Discussion Papers.
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  1. TVA sociale, tu perds ton sang-froid
    by Benjamin Ting in Economiam on 2012-11-06 20:41:00
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