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.
We thank Andrew Abel, Philippe Aghion, Alberto Alesina, Pol Antràs, Mark Aguiar, Gianluca Benigno, Raj Chetty, Arnaud Costinot, Michael Devereux, Charles Engel, Francesco Franco, Xavier Gabaix, Etienne Gagnon, Fabio Ghironi, Elhanan Helpman, Olivier Jeanne, Urban Jermann, Mike Golosov, João Gomes, Gene Grossman, John Leahy, Elias Papaioannou, Veronica Rappoport, Ricardo Reis, Richard Rogerson, Martín Uribe, Adrien Verdelhan, MichaelWoodford and seminar/conference participants at NES-HSE, ECB, Frankfurt, Princeton, Federal Reserve Board, Columbia, NBER IFM, Wharton, NYU, Harvard, MIT, NY Fed, LSE for their comments, and Eduard Talamas for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“Fiscal Devaluations” (with Gita Gopinath and Oleg Itskhoki) Review of Economic Studies, forthcoming. citation courtesy of