Abstract
The article uses a small open economy version of the macroeconomic general-equilibrium model QUEST to compare fiscal and nominal exchange rate (EXR) devaluation with respect to their impact on economic activity and the current account. In particular, the article investigates quantitatively to which extent fiscal devaluation mimics nominal EXR adjustment and mitigates the output loss associated with demand rebalancing and external adjustment by shifting adjustment from domestic demand contraction to export growth. Fiscal and monetary devaluation support external adjustment and mitigate its impact on economic activity in the presence of price and wage rigidities. The quantitative impact of a tax shift from labour to consumption as the standard example of fiscal devaluation remains very moderate, however (JEL codes: E52, F41, F47).
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