Is fiscal devaluation welfare enhancing? : A model-based analysis

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Hohberger, Stefan ; Kraus, Lena:
Is fiscal devaluation welfare enhancing? : A model-based analysis.
Bayreuth : Universität Bayreuth , 2015 . - 31 S. - (Wirtschaftswissenschaftliche Diskussionspapiere der Universität Bayreuth, Rechts- und Wirtschaftswissenschaftliche Fakultät ; 01-15 )

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Abstract

Large trade imbalances have emerged as major policy challenges for the euro area within the
last decade. As fiscal policy is the major macroeconomic policy instrument left with the
individual member countries of EMU, fiscal devaluation is a highly debated policy tool to
mimic the effects of an external devaluation by implementing a budgetary-neutral tax shift
from direct to indirect taxes. This paper uses a two-region two-sector DSGE model with
nominal wage and price rigidities to analyse the welfare effects of fiscal devaluation
understood as tax shift from social security contributions for employers to value-added tax in a small open economy in monetary union. This paper finds that fiscal devaluation can stabilise excessive trade balance fluctuations but implies welfare losses for the average household. The
results are robust to several sensitivity checks.