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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. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C99-107, University of California at Berkeley.
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  5. Isabel Horta Correia & Emmanuel Farhi & Juan Pablo Nicolini & Pedro Teles, 2011. "Unconventional Fiscal Policy at the Zero Bound," Working Papers, Banco de Portugal, Economics and Research Department w201103, Banco de Portugal, Economics and Research Department.
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  7. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "From World Banker to World Venture Capitalist: U.S. External Adjustment and the Exorbitant Privilege," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 11-66 National Bureau of Economic Research, Inc.
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  10. Carbonnier, Clement, 2007. "Who pays sales taxes? Evidence from French VAT reforms, 1987-1999," Journal of Public Economics, Elsevier, Elsevier, vol. 91(5-6), pages 1219-1229, June.
  11. Correia, Maria Isabel Horta & Nicolini, Juan Pablo & Teles, Pedro, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3730, C.E.P.R. Discussion Papers.
  12. Bénassy-Quéré, Agnès & Carré, Martine & Andrade, Philippe, 2010. "Competition and pass-through on international markets: Firm-level evidence from VAT shocks," Economics Papers from University Paris Dauphine, Paris Dauphine University 123456789/11165, Paris Dauphine University.
  13. Stephan Danninger & Alina Carare, 2008. "Inflation Smoothing and the Modest Effect of VAT in Germany," IMF Working Papers 08/175, International Monetary Fund.
  14. Devereux, Michael B. & Engel, Charles, 2007. "Expenditure switching versus real exchange rate stabilization: Competing objectives for exchange rate policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(8), pages 2346-2374, November.
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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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