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Fiscal policy in the European Monetary Union

Author

Listed:
  • Betty C. Daniel
  • Christos Shiamptanis
Abstract
A country entering the EMU surrenders its monetary policy, and its debt becomes denominated in terms of a currency over which it has no direct control. A country's promise to uphold the fiscal limits in the Maastricht Treaty and the Stability and Growth Pact is implicitly a promise not to allow its fiscal stance to deteriorate to a position in which it places pressure on the central bank to forgo its price level target to finance fiscal deficits. Violation of these limits has raised questions about potential fiscal encroachment on the monetary authority's freedom to determine the price level. We specify a simple model of fiscal policy in which the fiscal authority faces an upper bound on the size of its primary surplus. Policy is determined by a fiscal rule, specified as an error correction model, in which the primary surplus responds to debt and a target variable. We show that for the monetary authority to have the freedom to control price, the primary surplus must respond strongly enough to lagged debt. Using panel techniques that allow for unit roots and for heterogeneity and cross-sectional dependence across countries, we estimate the coefficients of the error correction model for the primary surplus in a panel of ten EMU countries over the period 1970-2006. The group mean estimate for the coefficient on lagged debt is consistent with the hypothesis that the monetary authority can control the price level in the EMU, independent of fiscal influence.

Suggested Citation

  • Betty C. Daniel & Christos Shiamptanis, 2008. "Fiscal policy in the European Monetary Union," International Finance Discussion Papers 961, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:961
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    Cited by:

    1. Julia del Amo Valor & Marcos Martín Mateos & Diego Martínez López & Javier J. Pérez, 2023. "Is the European economic governance framework too “complex”? A critical discussion," Working Papers 2023-06, FEDEA.
    2. Aldama, Pierre & Creel, Jérôme, 2019. "Fiscal policy in the US: Sustainable after all?," Economic Modelling, Elsevier, vol. 81(C), pages 471-479.
    3. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," Economic Papers, The Economic Society of Australia, vol. 30(1), pages 33-47, March.
    4. Pierre Aldama & Jérôme Creel, 2020. "Asymmetric Macroeconomic Stabilization And Fiscal Consolidation In The Oecd And The Euro Area," SciencePo Working papers Main hal-03403071, HAL.
    5. repec:hal:spmain:info:hdl:2441/8g1v863ou8ne8avs9kr75pav8 is not listed on IDEAS
    6. Michel Guillard & Hubert Kempf, 2017. "Public Debt Sustainability and Defaults," CESifo Working Paper Series 6554, CESifo.
    7. Richter, Alexander W., 2015. "Finite lifetimes, long-term debt and the fiscal limit," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 180-203.
    8. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
    9. repec:spo:wpmain:info:hdl:2441/7suq9gqkp186e8d6eou29dipgk is not listed on IDEAS
    10. Christos Shiamptanis, 2012. "Risk Assessment Under a Non-linear Fiscal Rule," Working Papers 038, Toronto Metropolitan University, Department of Economics.
    11. repec:hal:spmain:info:hdl:2441/7suq9gqkp186e8d6eou29dipgk is not listed on IDEAS
    12. Aldama Pierre & Jérôme Creel, 2016. "Why fiscal regimes matter for fiscal sustainability analysis : an application to France," Documents de Travail de l'OFCE 2016-15, Observatoire Francais des Conjonctures Economiques (OFCE).
    13. repec:hal:spmain:info:hdl:2441/c5gs2rgi93abt1s4jkeabou1 is not listed on IDEAS
    14. repec:spo:wpmain:info:hdl:2441/8g1v863ou8ne8avs9kr75pav8 is not listed on IDEAS
    15. Yu HSING, 2017. "Is more government debt or currency depreciation expansionary? The case of Poland," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(3(612), A), pages 63-70, Autumn.
    16. repec:spo:wpmain:info:hdl:2441/c5gs2rgi93abt1s4jkeabou1 is not listed on IDEAS
    17. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers 2010-3, Central Bank of Cyprus.
    18. Checherita-Westphal, Cristina & Žďárek, Václav, 2017. "Fiscal reaction function and fiscal fatigue: evidence for the euro area," Working Paper Series 2036, European Central Bank.
    19. Aura Gabriela SOCOL & Roxana Mirela FERARU, 2017. "The role of fiscal policy in the financial crisis. Challenges and solutions," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(2(611), S), pages 5-20, Summer.

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    More about this item

    Keywords

    Fiscal policy - European Union countries; Monetary policy - European Union countries;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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