Fiscal Devaluation: Economic Stimulus for Crisis Countries in the Euro Area

by  Kerstin Bernoth, Patrick Burauel and Philipp Engler in: DIW Economic Bulletin 10/2014

Member countries of the euro area, and the peripheral states in particular, face an especially difficult problem: on the one hand, they urgently need stronger economic growth to reduce high debt and unemployment levels. On the other hand, however, they have no scope to use fiscal policy to stimulate the economy. One way to strengthen economic growth without burdening public finances might be to implement a “fiscal devaluation.” This concept includes reducing social security contributions for employers—and therefore ancillary wage costs—making companies more price competitive than their foreign competitors. This, in turn, should stimulate exports and result in positive employment effects. Reducing ancillary wage costs could be financed by an increase in value-added tax. This study shows that a fiscal devaluation in the individual member countries of a currency union may help to boost economic growth in the short term. This instrument should therefore be particularly important for the crisis countries in the euro area, though it by no means replaces the structural reforms required to increase economic growth in the long term.

Fiscal Devaluation: Economic Stimulus for Crisis Countries in the Euro Area (PDF, 283.44 KB)