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Fiscal Devaluations

Author

Listed:
  • Farhi, Emmanuel
  • Gopinath, Gita
  • Itskhoki, Oleg

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.

Suggested Citation

  • Farhi, Emmanuel & Gopinath, Gita & Itskhoki, Oleg, 2011. "Fiscal Devaluations," CEPR Discussion Papers 8721, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8721
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    References listed on IDEAS

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    More about this item

    Keywords

    competitive devaluation; currency union; fiscal policy;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance

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