Working Paper: CEPR ID: DP14829
Authors: Javier Andrés; Oscar Arce; Jesús Fernández-Villaverde; Samuel Hurtado
Abstract: We study the macroeconomic effects of internal devaluations undertaken by a periphery of countries belonging to a monetary union. We find that internal devaluations have large and positive output effects in the long run. Through an expectations channel, most of these effects carry over to the short run. Internal devaluations focused on goods markets reforms are generally more powerful in stimulating growth than reforms aimed at moderating wages, but the latter are less deflationary. For a monetary union with a periphery the size of the euro area's, the countries at the periphery benefit from internal devaluations even at the zero lower bound (ZLB) of the nominal interest rate. Nevertheless, when the ZLB binds, there is a case for a sequencing of reforms that prioritizes labor policies over goods markets reforms.
Keywords: monetary union; internal devaluation; structural reforms; zero lower bound; policy sequencing
JEL Codes: E44; E63; D42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Internal devaluations (L16) | Large positive output effects (F69) |
| Internal devaluations focused on goods market reforms (E69) | More effective at stimulating growth (O49) |
| Labor market reforms (J48) | Smaller output effects and less deflationary pressure (E31) |
| Labor market reforms should be prioritized during a crisis (E69) | Monetary policy is constrained (E52) |
| Internal devaluations (L16) | Output effects through expectations channel (D84) |
| Goods market reforms (E69) | Output effects (E23) |
| Labor market reforms (J48) | Output effects (E23) |