Fiscal Devaluation in the Euro Area: A Model-Based Analysis

39 Pages Posted: 23 Aug 2014

See all articles by Sandra Gomes

Sandra Gomes

Bank of Portugal

Pascal Jacquinot

European Central Bank (ECB)

Massimiliano Pisani

Bank of Italy

Date Written: August 12, 2014

Abstract

We assess the effects on trade balance of a temporary fiscal devaluation enacted by Spain or Portugal by simulating EAGLE, a large-scale multi-country dynamic general equilibrium model of the euro area. Social contributions paid by firms are reduced by 1 percent of GDP for four years and are financed by increasing consumption tax. Our main results are the following. First, the Spanish trade balance improves by 0.5 percent of GDP, the (before-consumption tax) real exchange rate depreciates by 0.7 percent and the terms of trade deteriorate by 1 percent. Second, similar results are obtained in the case of Portugal. Third, the trade balance improves when the fiscal devaluation is enacted also in the rest of the euro area, albeit to a lower extent than in the case of unilateral (country-specific) implementation. Fourth, quantitative results crucially depend on the degree of substitutability between domestic and imported tradables.

Keywords: fiscal devaluation, trade deficit, dynamic general equilibrium modeling

JEL Classification: F32, F47, H20

Suggested Citation

Gomes, Sandra and Jacquinot, Pascal and Pisani, Massimiliano, Fiscal Devaluation in the Euro Area: A Model-Based Analysis (August 12, 2014). ECB Working Paper No. 1725, Available at SSRN: https://ssrn.com/abstract=2479317

Sandra Gomes (Contact Author)

Bank of Portugal ( email )

Rua Francisco Ribeiro, 2
Lisbon, 1150-165
Portugal

Pascal Jacquinot

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Massimiliano Pisani

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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