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Fiscal Devaluations

Author

Listed:
  • Emmanuel Farhi
  • Gita Gopinath
  • Oleg Itskhoki
Abstract
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.

Suggested Citation

  • Emmanuel Farhi & Gita Gopinath & Oleg Itskhoki, 2014. "Fiscal Devaluations," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(2), pages 725-760.
    • Handle: RePEc:oup:restud:v:81:y:2014:i:2:p:725-760
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    File URL: http://hdl.handle.net/10.1093/restud/rdt036
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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance

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