“To Deficit or Not to Deficit”: Should European Fiscal Rules Differ Among Countries?

Abstract

The creation of the European Monetary Union has led to a substantial increase in the discussion of the importance of fiscal discipline and adequate fiscal rules in such a monetary union. The “European” solution has been challenged by many authors and politicians: among the main questions discussed in recent years, we find the use of the same rules for different situations in Member-Countries, particularly in terms of economic dimension and economic level of development. We develop a model of a monetary union between two countries that may differ in economic dimension and in the level of development. By solving transitional dynamics towards the steady state through numerical computation, the model allows us to examine the impact of fiscal shocks that may lead to excessive deficits. Our results suggest that the implications of such deficits depend on whether they occur in the small and less developed country or in the big and more developed one. In this context, we argue that an excessive deficit should be temporarily allowed in the case of the small and less developed country, in order to improve economic convergence and wages within the union.Monetary Union; SGP; Excessive Deficits; Technological-Knowledge Gap; Numerical Computation.