Fiscal Devaluations / Emmanuel Farhi, Gita Gopinath, Oleg Itskhoki.

Format:

Book

Author/Creator:

Farhi, Emmanuel.

Contributor:

National Bureau of Economic Research.

Gopinath, Gita.

Itskhoki, Oleg.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17662.

NBER working paper series no. w17662

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

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.

Notes:

Print version record

December 2011.