DP14829 Deciphering the Macroeconomic Effects of Internal Devaluations in a Monetary Union

Author(s):	Javier Andrés, Oscar Arce, Jesús Fernández-Villaverde, Samuel Hurtado
Publication Date:	May 2020
Keyword(s):	internal devaluation, monetary union, policy sequencing, Structural reforms, zero lower bound
JEL(s):	D42, E44, E63
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14829

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.