## External Shocks, the Real Exchange Rate, and Tax Policy

_IMF Working Papers, August 1, 1994_

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## Bibliographic details
- Authors: Stephen Tokarick
- Published: August 1, 1994
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451851090.001

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### Summary
- Uses a computable general equilibrium model of the economy of Trinidad and Tobago to assess effects of:
  - trade liberalization; and
  - terms-of-trade shocks.
- Focuses on impacts on the real exchange rate and the overall fiscal position of the government.
- Evaluates implications of alternative tax policies designed to offset the increase in the budget deficit of the central government resulting from both types of external sector shocks.

### Model and methodology
- Computable general equilibrium (CGE) model calibrated to the economy of Trinidad and Tobago.
- Scenarios analyzed include trade liberalization and terms-of-trade deterioration/shocks.
- Model outputs used to trace effects on:
  - real exchange rate;
  - import volumes and importable goods;
  - exportable goods and world price PWM; and
  - government budget balance.

### Key findings
- External sector shocks (trade liberalization and terms-of-trade shocks) materially affect the real exchange rate.
- Both types of shocks lead to an increase in the budget deficit of the central government.
- Cross-price effects and consumer demand responses are important channels mediating real exchange rate and trade volume adjustments.
- Tariffs, value-added tax, and other tax instruments interact with trade reform to influence fiscal outcomes.

### Policy implications and recommendations
- Alternative tax policies can be designed to offset the increase in the central government budget deficit caused by external shocks.
- Tax policy design should consider:
  - the structure of tariffs and their reform under trade liberalization;
  - potential roles for value-added tax adjustments; and
  - distributional and sectoral impacts via traded and nontraded goods channels.
- Policymakers need to account for real exchange rate movements when choosing fiscal responses to external shocks.

### Subjects and keywords
- Subjects: Foreign exchange, Imports, International trade, Real exchange rates, Tariffs, Taxes, Trade liberalization, Value-added tax
- Keywords: consumer demand, cross-price effect, exchange rate, exportable good, import volume, importable good, Imports, Real exchange rates, Tariffs, terms of trade, terms-of-trade deterioration, Trade liberalization, trade reform, traded good, Value-added tax, world price PWM, WP

*Stephen Tokarick, "External Shocks, the Real Exchange Rate, and Tax Policy", IMF Working Papers 1994, 088 (1994).*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/external-shocks-the-real-exchange-rate-and-tax-policy-1147_