NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Fiscal Devaluations

Emmanuel Farhi, Gita Gopinath, Oleg Itskhoki

NBER Working Paper No. 17662
Issued in December 2011, Revised in June 2013
NBER Program(s):EFG, IFM, ITI, ME

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 dynamic New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions- producer or local currency pricing, along with nominal wage stickiness; under arbitrary degrees of asset market completeness and for general stochastic sequences of 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 are revenue neutral. 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.

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Document Object Identifier (DOI): 10.3386/w17662

Fiscal Devaluations” (with Gita Gopinath and Oleg Itskhoki) Review of Economic Studies, forthcoming. citation courtesy of

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