Fiscal Devaluations in EMU

Abstract

2013SummaryWe use a small open economy general equilibrium model to analyse the effects of a fiscal devalua-tion in an EMU country. The model has been calibrated for the Spanish economy, which is a goodexample of the advantages of a change in the tax mix given that its tax system shows a positive biasin the ratio of social security contributions over consumption taxes. The preliminary empirical evi-dence for European countries shows that this bias was negatively correlated with the current accountbalance in the expansionary years leading up to the 2009 crisis, a period when many EMU membersaccumulated large external imbalances. Our simulation results point to significant positive effects ofa fiscal devaluation on GDP and employment similar to the ones that could be obtained with an ex-change rate devaluation. However, although the effects in terms of GDP and employment are simi-lar, the composition effects of fiscal and nominal devaluations are not alike. In both cases, there isan improvement in net exports, but the effects on domestic and external demand are quite different