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Adjusting to external imbalances within the EMU, the case of Portugal

Listed author(s):
  • Francesco Franco
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    From 1995 to 2010 Portugal has accumulated a negative international asset position of 110 percent of GDP. In a developed and aging economy the number is astonishing and any argument to consider it sustainable must rely on extremely favorable forecasts on growth. Portuguese policy options are reduced in number: no autonomous monetary policy, no currency to devaluate, and limited discretion in changing fiscal deficits and government debt. To start the necessary deleveraging a remaining possible policy is a budget-neutral change of the tax structure that increases private saving and net exports. An increase in the VAT and a decrease in the employer’s social security contribution tax can achieve the desired outcome in the short run if they are complemented with wage moderation. To obtain a substantial improvement in competitiveness and a large decrease in consumption, the changes in the tax rates have to be large. While a precise quantitative assessment is difficult, the initial increase in the effective VAT rate needed to allow the social security tax to decrease by 16 percentage points (pp) is approximately 10 pp. Such a large increase in the effective VAT rate could be obtained by raising most of the reduced VAT rates to the new general VAT rate of 23 percent. The empirical analysis shows that over time the suggested tax swap could generate surpluses and improve the trade balance. A temporary version of the suggested tax-swap has the attractiveness to achieve a sharper increase in the private saving rate maintaining the short run gains in competitiveness. Finally, the temporary version of the fiscal devaluation could be the basis for an automatic stabilizer to external imbalances within a monetary union. JEL codes:

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    Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp556.

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    Length: 53 pages
    Date of creation: 2011
    Handle: RePEc:unl:unlfep:wp556
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    1. Olivier Blanchard & Jordi Galí, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.
    2. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 67-146.
    3. von Thadden, Leopold & Lipińska, Anna, 2009. "Monetary and fiscal policy aspects of indirect tax changes in a monetary union," Working Paper Series 1097, European Central Bank.
    4. Adao, Bernardino & Correia, Isabel & Teles, Pedro, 2009. "On the relevance of exchange rate regimes for stabilization policy," Journal of Economic Theory, Elsevier, vol. 144(4), pages 1468-1488, July.
    5. Jörg Decressin & Emil Stavrev, 2009. "Current Accounts in a Currency Union," IMF Working Papers 09/127, International Monetary Fund.
    6. European Commission, 2009. "Taxation trends in the European Union: 2009 edition," Taxation trends 2009, Directorate General Taxation and Customs Union, European Commission.
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