Does Austerity Go Along With Internal Devaluations?

Cuts to government spending rather than increases in consumption taxes are statistically associated with internal devaluations in the euro area during the period 2010-2014. Countries that cut spending experienced a decline in nominal wages, rising net exports, a fall in the relative price of non-tradables and a shift of consumption towards non-tradables. We show that these patterns are generally consistent with a neoclassical small open economy model with GHH preferences. The main remaining discrepancy between model and data is a missing terms of trade response in the data: Export prices did not decline in austere countries (nor did import prices), giving rise to asymmetric expenditure switching: Current account improvements are solely driven by falls in imports rather than increasing exports.

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IMF Economic Review, 67, 3
Aug 13 2019
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 Record created 2019-05-20, last modified 2020-04-16

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