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Pushing the Limit? Fiscal Policy in the European Monetary Union

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  • Betty Daniel

    ()
    (Department of Economics, University at Albany, Albany, New York, US)

  • Christos Shiamptanis

    ()
    (Department of Economics, Ryerson University, Toronto, Canada)

Abstract

Governments are facing increasing scrutiny over debt and deficits following the worldwide recession and financial crisis which began in 2007. Additionally, policy makers are confronted with the growing realization that they face fiscal limits on the size of debt and deficits relative to GDP. These fiscal limits invalidate Bohn's criterion for fiscal sustainability since it allows explosive debt relative to GDP, eventually violating any fiscal limit. The purpose of this paper is to derive restrictions on a fiscal rule, necessary for the government to eliminate explosive behavior. We show that the restrictions require that the response of the primary surplus to debt be relatively strong. Additionally, since fiscal limits rule out explosive behavior, they imply cointegration between debt and the primary surplus, and between the primary surplus and output. We test these two empirical implications for a panel of eleven EMU countries, and find that fiscal policy is responsible, in the sense that governments rule out explosive behavior.

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Bibliographic Info

Paper provided by Ryerson University, Department of Economics in its series Working Papers with number 033.

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Length: 41 pages
Date of creation: Jun 2012
Date of revision:
Handle: RePEc:rye:wpaper:wp033

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Keywords: European Monetary Union; monetary policy; fiscal policy; fiscal limits; panel cointegration; error correction;

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Cited by:
  1. Cristos Shiamptanis, 2014. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," LCERPA Working Papers wm0070, Laurier Centre for Economic Research and Policy Analysis, revised 1970.
  2. 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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