Deciphering the Macroeconomic Effects of Internal Devaluations in a Monetary Union
38 Pages Posted: 15 Jun 2020 Last revised: 23 Mar 2023
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Deciphering the Macroeconomic Effects of Internal Devaluations in a Monetary Union
Deciphering the Macroeconomic Effects of Internal Devaluations in a Monetary Union
Deciphering the Macroeconomic Effects of Internal Devaluations in a Monetary Union
Date Written: June 2020
Abstract
We study the macroeconomic effects of internal devaluations undertaken by a periphery of countries belonging to a monetary union. We find that internal devaluations have large and positive output effects in the long run. Through an expectations channel, most of these effects carry over to the short run. Internal devaluations focused on goods markets reforms are generally more powerful in stimulating growth than reforms aimed at moderating wages, but the latter are less deflationary. For a monetary union with a periphery the size of the euro area's, the countries at the periphery benefit from internal devaluations even at the zero lower bound (ZLB) of the nominal interest rate. Nevertheless, when the ZLB binds, there is a case for a sequencing of reforms that prioritizes labor policies over goods markets reforms.
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