TY - JOUR
AU - Farhi,Emmanuel
AU - Gopinath,Gita
AU - Itskhoki,Oleg
TI - Fiscal Devaluations
JF - National Bureau of Economic Research Working Paper Series
VL - No. 17662
PY - 2011
Y2 - December 2011
UR - http://www.nber.org/papers/w17662
L1 - http://www.nber.org/papers/w17662.pdf
N1 - Author contact info:
Emmanuel Farhi
Harvard University
Department of Economics
Littauer Center
Cambridge, MA 02138
Tel: 617/496-1835
Fax: 617/495-8570
E-Mail: efarhi@harvard.edu
Gita Gopinath
Department of Economics
Harvard University
1875 Cambridge Street
Littauer 206
Cambridge, MA 02138
Tel: 617/495-8161
Fax: 617/495-7730
E-Mail: gopinath@harvard.edu
Oleg Itskhoki
Department of Economics
Princeton University
Fisher Hall 306
Princeton, NJ 08544-1021
Tel: 609/258-5493
Fax: 609/258-6419
E-Mail: itskhoki@princeton.edu
AB - 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.
ER -