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Fiscal devaluations

  • Emmanuel Farhi
  • Gita Gopinath
  • Oleg Itskhoki

The authors show that even when the exchange rate cannot be devalued, a small set of conventional fiscal policy instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a standard New Keynesian open economy environment. They 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 the import tariff and export subsidy, and two, an increase in the value-added tax and a uniform reduction in the payroll tax. When the devaluations are anticipated, these policies need to be supplemented with a reduction in the consumption tax and an increase in income taxes. These policies have zero impact on fiscal revenues. In certain cases equivalence requires in addition a partial default on foreign bondholders. They discuss the issues regarding implementation of these policies, in particular in the case of a currency union.

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Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 12-10.

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Date of creation: 2012
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Handle: RePEc:fip:fedbwp:12-10
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  1. Hevia, Constantino & Nicolini, Juan Pablo, 2009. "Optimal devaluations," Policy Research Working Paper Series 4926, The World Bank.
  2. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal fiscal and monetary policy: equivalence results," Staff Report 403, Federal Reserve Bank of Minneapolis.
  3. repec:ner:dauphi:urn:hdl:123456789/11165 is not listed on IDEAS
  4. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," NBER Working Papers 11563, National Bureau of Economic Research, Inc.
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  9. Isabel Correia & Emmanuel Farhi & Juan Pablo Nicolini & Pedro Teles, 2011. "Unconventional Fiscal Policy at the Zero Bound," NBER Working Papers 16758, National Bureau of Economic Research, Inc.
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  16. J. Boscá & A. Díaz & R. Doménech & J. Ferri & E. Pérez & L. Puch, 2010. "A rational expectations model for simulation and policy evaluation of the Spanish economy," SERIEs, Spanish Economic Association, vol. 1(1), pages 135-169, March.
  17. European Commission, 2011. "Taxation trends in the European Union: 2011 edition," Taxation trends 2011, Directorate General Taxation and Customs Union, European Commission.
  18. Carbonnier, Clement, 2007. "Who pays sales taxes? Evidence from French VAT reforms, 1987-1999," Journal of Public Economics, Elsevier, vol. 91(5-6), pages 1219-1229, June.
  19. Devereux, Michael B. & Engel, Charles, 2007. "Expenditure switching versus real exchange rate stabilization: Competing objectives for exchange rate policy," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2346-2374, November.
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