Fiscal Devaluations by Emmanuel Farhi, Gita Gopinath, Oleg Itskhoki (8/2011).
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 standard New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions producer or local currency pricing, along with nominal wage stickiness; under alternative asset market structures, and for anticipated and unanticipated devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation one, a uniform increase in import tari and export subsidy, and two, an increase in value-added tax and a uniform reduction in payroll tax. When the devaluations are anticipated, these policies need to be supplemented with a reduction in consumption tax and an increase in income taxes. These policies have zero impact on fiscal revenues. 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.
Adjusting to external imbalances within the EMU, the case of Portugal by Francesco Franco (2011).
From 1995 to 2010 Portugal has accumulated a net external assets of 110 percent of GDP. In a developed and aging economy the number is astonishing and any argument to consider it sustainable must rely on extremely favorable forecasts on growth. Portuguese policy options are reduced in number: no autonomous monetary policy, no currency to devaluate, and very limited discretion in changing fiscal deficits and government debt. To start the necessary deleveraging a remaining possible policy is a budget-neutral change of the tax structure that increases private saving and net exports. An increase in the VAT and a decrease in the Payroll tax can achieve the desired outcome in the short run if they are complemented with wage moderation. To obtain a substantial improvement in competitiveness and a large decrease in consumption the changes in the tax rates have to be large. While a precise quantitative assessment is difficult, the initial increase in the effective VAT rate needed to allow the Payroll tax to decrease by 16 percentage points (pp) is approximately 10 pp. Such a large increase in the effective VAT rate could be obtained by raising most of the reduced VAT rates to the new general VAT rate of 23 percent. A temporary version of the suggested tax-swap has the attractiveness to achieve a sharper increase in the private saving rate maintaining the short run gains in competitiveness. Finally the temporary version of the fiscal devaluation has some resemblance to an automatic stabilizer to external imbalances within a monetary union.
