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Is fiscal devaluation welfare enhancing? A model-based analysis

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  • Hohberger, Stefan
  • Kraus, Lena

Abstract

Large trade imbalances have emerged as major policy challenges for the euro area within the last decade. As fiscal policy is the major macroeconomic policy instrument left with the individual member countries of EMU, fiscal devaluation is a highly debated policy tool to mimic the effects of an external devaluation by implementing a budgetary-neutral tax shift from direct to indirect taxes. This paper uses a two-region two-sector DSGE model with nominal wage and price rigidities to analyse the welfare effects of fiscal devaluation understood as tax shift from social security contributions for employers to value-added tax in a small open economy in monetary union. This paper finds that fiscal devaluation can stabilise excessive trade balance fluctuations but implies welfare losses for the average household. The results are robust to several sensitivity checks.

Suggested Citation

  • Hohberger, Stefan & Kraus, Lena, 2015. "Is fiscal devaluation welfare enhancing? A model-based analysis," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113193, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc15:113193
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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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