Fiscal policy in EMU: Rules, discretion and political incentives

The fiscal philosophy of EMU's budgetary rules is to bring deficits close to balance and then let automatic stabilisers play freely. Given the large tax and benefit systems in Europe, relying mainly on automatic stabilisation would allow a relatively high degree of cyclical smoothing while avoiding the typical pitfalls of fiscal activism. While this is, in most circumstances, good economic policy, it is evidently not regarded as good politics. The current difficulties of EMU's fiscal policy framework have little to do with its alleged fault lines and much to do with the resurgence of electoral budget cycles amid a weak system of incentives to abide by the agreed rules.EMU, economic and monetary union, fiscal policy, taxation, budgetary regulation, Marco Buti, van den Noord

What is the impact of tax and welfare reforms on fiscal stabilisers? A simple model and an application to EMU

Reforms aiming at lowering the tax burden and cutting social benefits may boost efficiency and output, and improve market adjustment to shocks, but, by reducing the size of automatic stabilisers, may also imply less cyclical smoothing. This would be problematic in EMU given the loss of national monetary autonomy. This paper argues that the alleged trade-off between efficiency/flexibility and stabilisation depends on the typology of shocks affecting the economy.taxation, tax reforms, fiscal policy, social welfare, social benefits, fiscal stabilisers, automatic stabilisers, economic and monetary union, EMU, shocks, Buti, Van den Noord

The rationale for a safe asset and fiscal capacity for the Eurozone. LEQS Paper No. 144/2019 May 2019

The only way to share common liabilities in the Eurozone is to achieve full fiscal and political union, i.e. unity of liability and control. In the pursuit of that goal, there is a need to smooth the transition, avoid unnecessary strains to macroeconomic and financial stability and lighten the burden of stabilisation policies from national sovereigns and the European Central Bank, while preserving market discipline and avoiding moral hazard. Both fiscal and monetary policy face constraints linked to the high legacy debt in some countries and the zero-lower-bound, respectively, and thus introducing Eurozone ‘safe assets’ and fiscal capacity at the centre would strengthen the transmission of monetary and fiscal policies. The paper introduces a standard Mundell-Fleming framework adapted to the features of a closed monetary union, with a two-country setting comprising a ‘core’ and a ‘periphery’ country, to evaluate the response of policy and the economy in case of symmetric and asymmetric demand and supply shocks in the current situation and following the introduction of safe bonds and fiscal capacity. Under the specified assumptions, it concludes that a safe asset and fiscal capacity, better if in combination, would remove the doom loop between banks and sovereigns, reduce the loss in output for both economies and improve the stabilisation properties of fiscal policy for both countries, and thus is welfare enhancing

The stability and growth pact: lessons from the great recession.

While current instruments of EU economic policy coordination helped stave off a full-scale depression, the post-2007 global financial and economic crisis has revealed a number of weaknesses in the Stability and Growth Pact, the EU framework for fiscal surveillance and fiscal policy coordination. This paper provides a diagnosis of how the SGP faired ahead and during the present crisis and offers a first comprehensive review of the ongoing academic and policy debate, including an account of the reform proposals adopted by the Commission on 29 September 2010. In our view, the current system of EU rules is unbalanced. It consists of (i) very specific provisions on how to conduct fiscal policy making in normal times with no effective enforcement mechanisms, and of (ii) no or extremely tight provisions for really bad economic times, like the Great Recession. A two-pronged approach as outlined in this report is needed to revive the Pact: tighter enforcement, coupled with broader macroeconomic surveillance, in good times and an open window for exceptionally bad times, including a crisis resolution mechanism at the EU level.Stability and Growth Pact, EU, Europe, the euro, Great Recession, fiscal sovereignty

The Stability and Growth Pact: Lessons from the Great Recession

While current instruments of EU economic policy coordination helped stave off a full-scale depression, the post-2007 global financial and economic crisis has revealed a number of weaknesses in the Stability and Growth Pact, the EU framework for fiscal surveillance and fiscal policy coordination. This paper provides a diagnosis of how the SGP faired ahead and during the present crisis and offers a first comprehensive review of the ongoing academic and policy debate, including an account of the reform proposals adopted by the Commission on 29 September 2010. In our view, the current system of EU rules is unbalanced. It consists of (i) very specific provisions on how to conduct fiscal policy making in normal times with no effective enforcement mechanisms, and of (ii) no or extremely tight provisions for really bad economic times, like the Great Recession. A two-pronged approach as outlined in this report is needed to revive the Pact: tighter enforcement, coupled with broader macroeconomic surveillance, in good times and an open window for exceptionally bad times, including a crisis resolution mechanism at the EU level.

Heterogeneity in money holdings across euro area countries: The role of housing

In this paper we examine why monetary aggregates of euro area Member States have developed differently since the inception of the euro. We derive a money demand equation that incorporates housing wealth and collateral as well as substitution effects on real money holdings. Empirically, we show that cross-country differences in real balances are determined not only by income differences, a standard determinant of money demand, but also by house price developments. Higher house prices and higher user costs of housing are both associated with larger money holdings. Country-specific money holdings are also connected with structural features of the housing market. --Money,housing,national contribution,euro area

Assessing next generation EU

The unprecedented fiscal package adopted by the European Council this summer – dubbed Next Generation EU – is vital for the recovery of the euro area, write Lorenzo Codogno and Paul van den Noord. However, they estimate that the creation of a Eurobond and permanent fiscal capacity at the centre would have been a more powerful means to mitigate the impact of the crisis

Going fiscal? A stylised model with fiscal capacity and a safe asset in the Eurozone

This paper examines the impact of rebalancing the policy mix away from monetary towards fiscal stimu-lus in the Euro zone, achieved at the supranational level by introducing a safe asset together with fiscal capacity at the centre. The model used is consensus Mundel-Fleming for a two-country ('core' and 'periphery') closed economy adapted to the critical features of Europe's Economic and Monetary Union. Specifically, alongside the determination of output, inflation and trade, the determination of financial flows and yields is explicitly modelled while the internal nominal exchange rate is fixed. Simulations are run in which a safe asset - dubbed Eurobond - replaces national bonds on banks and central bank's balance sheets, and a fiscal capacity at the center with the power to adjust the ag-gregate fiscal stance is introduced. Moreover, a new quantitative easing scheme, mandating the European Central Bank to adjust its portfolio of Eurobonds as deemed necessary in the pursuit of price stability, is introduced. The main conclusion emerging from the simulations is that had a Eurobond/fiscal capacity existed at the onset of the Great Financial Crisis, the recession would have been much more muted, and with much less need for unconvention-al monetary policy

The stability and growth pact: lessons from the great recession.

While current instruments of EU economic policy coordination helped stave off a full-scale depression, the post-2007 global financial and economic crisis has revealed a number of weaknesses in the Stability and Growth Pact, the EU framework for fiscal surveillance and fiscal policy coordination. This paper provides a diagnosis of how the SGP faired ahead and during the present crisis and offers a first comprehensive review of the ongoing academic and policy debate, including an account of the reform proposals adopted by the Commission on 29 September 2010. In our view, the current system of EU rules is unbalanced. It consists of (i) very specific provisions on how to conduct fiscal policy making in normal times with no effective enforcement mechanisms, and of (ii) no or extremely tight provisions for really bad economic times, like the Great Recession. A two-pronged approach as outlined in this report is needed to revive the Pact: tighter enforcement, coupled with broader macroeconomic surveillance, in good times and an open window for exceptionally bad times, including a crisis resolution mechanism at the EU level