Working Paper

On the (in)effectiveness of fiscal devaluations in a monetary union

Abstract: This paper explores the fiscal devaluation hypothesis in a model of a monetary union characterised by national fiscal policies and supranational monetary policy. We show that a unilateral tax shift towards indirect taxes in one of the countries produces small but non-negligible long run effects on output and consumption within and between the two countries only when international financial markets are perfectly integrated. In contrast to the existing literature, we find that short-run effects are not always amplified by nominal wage rigidities. We document also how short-run effects of the tax shift depend on the choice of the inflation index stabilized by the central bank and on whether the tax shift is anticipated.

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2012

Number: 2012-71