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Fiscal devaluation and labour market frictions in a monetary union

Author

Listed:
  • Lorenzo Burlon

    () (European Central Bank)

  • Alessandro Notarpietro

    () (Bank of Italy)

  • Massimiliano Pisani

    () (Bank of Italy)

Abstract

We assess the effects of a fiscal devaluation on economic and labour market conditions in a Member State of the euro area by simulating a monetary union model featuring labour markets with search and matching frictions. The fiscal authority of the Member State enacts a discretionary reduction in the social contribution rate for employers so that the corresponding revenues decrease by 1per cent of the before-shock (steady-state) nominal GDP. The measure is ex ante revenue neutral, because it is financed by a simultaneous discretionary increase in the consumption tax rate that generates additional ex ante revenues equal to 1 per cent of the before-shock GDP. The main results are as follows. First, GDP increases by 0.5 per cent, sustained by the increase in investment and net exports, while consumption decreases. Second, the unemployment rate decreases by 0.3 percentage points. Third, the trade balance improvement is equal to 0.3 per cent of GDP (the improvement in real net exports is partially offset by the deterioration in term of trade). Fourth, the results are rather robust to changes in key parameters.

Suggested Citation

  • Lorenzo Burlon & Alessandro Notarpietro & Massimiliano Pisani, 2019. "Fiscal devaluation and labour market frictions in a monetary union," Temi di discussione (Economic working papers) 1241, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1241_19
    as

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    File URL: https://www.bancaditalia.it/pubblicazioni/temi-discussione/2019/2019-1241/en_tema_1241.pdf
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    References listed on IDEAS

    as
    1. Sandra Gomes & Pascal Jacquinot & Matthias Mohr & Massimiliano Pisani, 2013. "Structural Reforms and Macroeconomic Performance in the Euro Area Countries: A Model-Based Assessment," International Finance, Wiley Blackwell, vol. 16(1), pages 23-44, February.
    2. Warne, Anders & Coenen, G√ľnter & Christoffel, Kai, 2008. "The new area-wide model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 944, European Central Bank.
    3. Francesco Franco, 2011. "Adjusting to external imbalances within the EMU, the case of Portugal," FEUNL Working Paper Series wp556, Universidade Nova de Lisboa, Faculdade de Economia.
    4. Christoffel, Kai & Kuester, Keith & Linzert, Tobias, 2009. "The role of labor markets for euro area monetary policy," European Economic Review, Elsevier, vol. 53(8), pages 908-936, November.
    5. Pascal Jacquinot & Matija Lozej & Massimiliano Pisani, 2018. "Labor Tax Reforms, Cross-Country Coordination, and the Monetary Policy Stance in the Euro Area: A Structural Model-Based Approach," International Journal of Central Banking, International Journal of Central Banking, vol. 14(3), pages 65-140, June.
    6. European Commission, 2018. "Taxation trends in the European Union: 2018 edition," Taxation trends 2018, Directorate General Taxation and Customs Union, European Commission.
    7. Gomes, S. & Jacquinot, P. & Pisani, M., 2016. "Fiscal devaluation in the euro area: A model-based analysis," Economic Modelling, Elsevier, vol. 52(PA), pages 58-70.
    8. Laxton, Douglas & Pesenti, Paolo, 2003. "Monetary rules for small, open, emerging economies," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1109-1146, July.
    9. Douglas Laxton, 2008. "Getting to Know the Global Economy Model and Its Philosophy," IMF Staff Papers, Palgrave Macmillan, vol. 55(2), pages 213-242, June.
    10. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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    More about this item

    Keywords

    fiscal devaluation; labour market; trade deficit; dynamic general equilibrium modelling;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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