Fiscal Devaluations

66 Pages Posted: 26 Jun 2013

See all articles by Emmanuel Farhi

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Gita Gopinath

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Oleg Itskhoki

Princeton University - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: October 18, 2012

Abstract

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.

JEL Classification: E32, E60, F30

Suggested Citation

Farhi, Emmanuel and Gopinath, Gita and Itskhoki, Oleg, Fiscal Devaluations (October 18, 2012). FRB of Boston Working Paper No. 12-10. Available at SSRN: https://ssrn.com/abstract=2285069 or http://dx.doi.org/10.2139/ssrn.2285069

Emmanuel Farhi

Harvard University - Department of Economics ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Gita Gopinath (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Oleg Itskhoki

Princeton University - Department of Economics ( email )

Fisher 306
Princeton, NJ 08544-1021
United States
+1 (609) 258-5493 (Phone)

HOME PAGE: http://www.princeton.edu/~itskhoki

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