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Fiscal risk in a monetary union

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  • Daniel, Betty C.
  • Shiamptanis, Christos

Abstract

We present a dynamic and quantitative model of a fiscal solvency crisis in a monetary union. Diverse fiscal policies, which are subject to fiscal limits and stochastic shocks, can threaten a monetary union. The fiscal limits arise due to distortionary taxation and political will. Stochastic shocks are random and could push a fiscally sound policy towards its limit. In equilibrium agents refuse to lend along a path which violates the fiscal limits, creating a fiscal solvency crisis. The dynamics leading to the crisis depend on the policy response to restore lending. We focus on two responses, default and policy switching. We simulate our model to quantify the probability of a fiscal solvency crisis in the European Monetary Union with fiscal variables at end of 2009 values. Our model predicts the Greek crisis which occurred and warns of an Italian one.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 56 (2012)
Issue (Month): 6 ()
Pages: 1289-1309

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Handle: RePEc:eee:eecrev:v:56:y:2012:i:6:p:1289-1309

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Web page: http://www.elsevier.com/locate/eer

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Keywords: European monetary union; Fiscal theory of the price level; Policy switching; Default; Financial crisis;

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Citations

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Cited by:
  1. Huixin Bi, 2011. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," Working Papers 11-10, Bank of Canada.
  2. Eric M. Leeper & Todd B. Walker, 2012. "Perceptions and Misperceptions of Fiscal Inflation," NBER Working Papers 17903, National Bureau of Economic Research, Inc.
  3. Christos Shiamptanis, 2012. "Risk Assessment Under a Non-linear Fiscal Rule," Working Papers 038, Ryerson University, Department of Economics.
  4. 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.).
  5. Betty Daniel, 2008. "Exchange Rate Crises and Fiscal Solvency," Discussion Papers 08-09, University at Albany, SUNY, Department of Economics.
  6. repec:wlu:lcerpa:wm0070 is not listed on IDEAS
  7. Betty Daniel & Christos Shiamptanis, 2012. "Pushing the Limit? Fiscal Policy in the European Monetary Union," Working Papers 033, Ryerson University, Department of Economics.
  8. Falko Juessen & Ludger Linnemann & Andreas Schabert, 2014. "Default Risk Premia on Government Bonds in a Quantitative Macroeconomic Model," Working Paper Series in Economics 73, University of Cologne, Department of Economics.
  9. Christos Shiamptanis, 2014. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," LCERPA Working Papers lm0063, Laurier Centre for Economic Research and Policy Analysis, revised Jun 2014.

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