Does fiscal devaluation always work? A sectoral and business cycle perspective

Abstract The study verifies effects of fiscal devaluation on a broad set of sector and firm-level macroeconomic variables among European economies in years 1995–2019. Using local projection and panel data models it finds that fiscal devaluation impact on employment is stronger in services and small businesses, where production is most labour intensive. In turn, in manufacturing, where production is capital intensive, firms may substitute capital for labour in response to fiscal devaluation. Lastly, fiscal devaluation favours employment in recessions more than in times of economic expansions, as only in recessions it reduces labour costs in a more lasting way.