Series: Working Papers. 2016.
Author: Javier Andrés, Óscar Arce, Jesús Fernández-Villaverde and Samuel Hurtado.
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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.