Fiscal Policy, Relative Prices and Net Exports in a Currency Union
When several euro-area countries implemented fiscal austerity measures in the early 2010s, the hoped-for silver lining was that this would make their economy more competitive in international markets.
Using product- and sector-level data for 12 countries over 1999-2018, the authors show that government spending cuts indeed reduced prices and wages, but only for non-traded products and sectors serving the domestic market. Consequently, spending cuts did not translate into lower export prices, dashing hopes of raising exports. The researchers rationalize these findings by pointing out that spending cuts were concentrated in non-exporting sectors and that the resulting wage cuts in those sectors did not have an impact on wages in exporting sectors since there is not enough movement of workers across these sectors.