Effects of Cross Country Fiscal Interdependence on Multipliers within a Monetary Union

This paper analyzes the e ects of time-varying fiscal policy behavior on output and consumption multipliers within a monetary union. The framework is that of a standard New Keynesian two-country model with distortionary taxes and Calvo price rigidities. I first show that multipliers differ significantly across fiscal regime mixes that follow a two-state Markov switching process. For each country, I differentiate between active, where spending is mainly deficit-financed, and passive, when spending is mainly tax-financed, behavior. Since this analysis is based on the Euro Area, I abstract from fiscal-monetary interaction and focus on member and union fiscal interdependence, including monetary imperfections and trade e ects. My calibration results show that consumption multipliers to be small and negative. However, the output multiplier is positive and possibly larger than one, depending on the persistence and openness of a country. Moreover, the optimal fiscal regime mix is a combination of active/passive since the negative wealth effect is lowest and the terms of trade loss are the smallest.