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Smoothing shocks and balancing budgets in a currency union

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  • James Costain

    ()
    (Banco de España)

  • Beatriz de Blas

    (Universidad autónoma de Madrid)

Abstract

We study simple fiscal rules for stabilizing the government debt level in response to asymmetric demand shocks in a country that belongs to a currency union. We compare debt stabilization through tax rate adjustments with debt stabilization through expenditure changes. While rapid and flexible adjustment of public expenditure might seem institutionally or informationally infeasible, we discuss one concrete way in which this might be implemented: setting salaries of public employees, and social transfers, in an alternative unit of account, and delegating the valuation of this numeraire to an independent fiscal authority. Using a sticky-price DSGE matching model of a small open economy in a currency union, we compare the business cycle implications of several different fiscal rules that all achieve the same reduction in the standard deviation of the public debt. In our simulations, compared with rules that adjust tax rates, a rule that stabilizes the budget by adjusting public salaries and transfers reduces fluctuations in consumption, employment, and private and public after-tax real wages, thus bringing the market economy closer to the social planner’s solution.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/12/Fich/dt1207e.pdf
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1207.

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Length: 56 pages
Date of creation: Jan 2012
Date of revision:
Handle: RePEc:bde:wpaper:1207

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Keywords: Fiscal authority; public wages; sovereign debt; monetary union;

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers, Rutgers University, Department of Economics 200115, Rutgers University, Department of Economics.
  2. Gomes, Pedro Maia, 2010. "Fiscal Policy and the Labour Market: The Effects of Public Sector Employment and Wages," IZA Discussion Papers 5321, Institute for the Study of Labor (IZA).
  3. Alesina, Alberto & Perotti, Roberto, 1996. "Fiscal Discipline and the Budget Process," American Economic Review, American Economic Association, American Economic Association, vol. 86(2), pages 401-07, May.
  4. W.H. Buiter, 2007. "Is Numérairology the Future of Monetary Economics? Unbundling numéraire and medium of exchange through a virtual currency and a shadow exchange rate," CEP Discussion Papers, Centre for Economic Performance, LSE dp0776, Centre for Economic Performance, LSE.
  5. Carlos Thomas, 2006. "Search and matching frictions and optimal monetary policy," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 19782, London School of Economics and Political Science, LSE Library.
  6. Giancarlo Corsetti & André Meier & Gernot J. Müller, 2012. "Fiscal Stimulus with Spending Reversals," The Review of Economics and Statistics, MIT Press, vol. 94(4), pages 878-895, November.
  7. Xavier Debrun & David Hauner & Manmohan S. Kumar, 2009. "Independent Fiscal Agencies," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 23(1), pages 44-81, 02.
  8. Charles Wyplosz, 2005. "Fiscal Policy: Institutions versus Rules," National Institute Economic Review, National Institute of Economic and Social Research, National Institute of Economic and Social Research, vol. 191(1), pages 64-78, January.
  9. Luca Sala & Antonella Trigari & Mark Gertler, 2007. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," 2007 Meeting Papers, Society for Economic Dynamics 353, Society for Economic Dynamics.
  10. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  11. Eric M. Leeper, 2009. "Anchoring Fiscal Expectations," NBER Working Papers 15269, National Bureau of Economic Research, Inc.
  12. Bruche, Max & Suarez, Javier, 2010. "Deposit insurance and money market freezes," Journal of Monetary Economics, Elsevier, Elsevier, vol. 57(1), pages 45-61, January.
  13. Costain, James & de Blas, Beatriz, 2012. "The role of fiscal delegation in a monetary union: a survey of the political economy issues," Working Papers in Economic Theory 2012/11, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).
  14. Tatiana Kirsanova & Simon Wren-Lewis, 2006. " Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," CDMA Conference Paper Series, Centre for Dynamic Macroeconomic Analysis 0609, Centre for Dynamic Macroeconomic Analysis.
  15. Gernot Müller & Giancarlo Corsetti & André Meier, 2009. "Fiscal Stimulus with Spending Reversals," IMF Working Papers 09/106, International Monetary Fund.
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Cited by:
  1. Costain, James & de Blas, Beatriz, 2012. "The role of fiscal delegation in a monetary union: a survey of the political economy issues," Working Papers in Economic Theory 2012/11, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).

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