Fiscal Devaluation in the Euro Area: A Model-Based Analysis
39 Pages Posted: 23 Aug 2014
Date Written: August 12, 2014
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: Suggested Citation