The Distributional Implications of Fiscal Devaluations

Abstract

This paper explores the distributional implications of a fiscal devaluation acquired through a shift from labor to consumption taxes in an open-economy Heterogeneous Agents New Keynesian model with incomplete markets and uninsurable income risk. A permanent fiscal devaluation perfectly mimicking a nominal devaluation in aggregate implies an increase in transfers balanced by lower profits. This leaves the representative agent unaffected. However, as the higher transfers affect all agents symmetrically, while decreased profits impact agents according to their wealth, distributional effects arise. The implicit insurance provided by higher transfers benefits wealth-poor agents and mitigates the equity concerns associated with fiscal devaluations.