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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.

Suggested Citation

  • Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
  • Handle: RePEc:eee:eecrev:v:56:y:2012:i:6:p:1289-1309
    DOI: 10.1016/j.euroecorev.2012.04.004
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    Cited by:

    1. Juessen, Falko & Linnemann, Ludger & Schabert, Andreas, 2016. "Default Risk Premia On Government Bonds In A Quantitative Macroeconomic Model," Macroeconomic Dynamics, Cambridge University Press, vol. 20(01), pages 380-403, January.
    2. Daniel, Betty C. & Shiamptanis, Christos, 2013. "Pushing the limit? Fiscal policy in the European Monetary Union," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2307-2321.
    3. Eric M. Leeper & Todd B. Walker, 2012. "Perceptions and Misperceptions of Fiscal Inflation," NBER Chapters,in: Fiscal Policy after the Financial Crisis, pages 255-299 National Bureau of Economic Research, Inc.
    4. Betty C. Daniel, 2010. "Exchange Rate Crises and Fiscal Solvency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1109-1135, September.
    5. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
    6. Christos Shiamptanis, 2012. "Risk Assessment Under a Non-linear Fiscal Rule," Working Papers 038, Ryerson University, Department of Economics.
    7. Christos Shiamptanis, 2015. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," Economic Inquiry, Western Economic Association International, vol. 53(3), pages 1539-1555, July.
    8. Hürtgen, Patrick & Rühmkorf, Ronald, 2014. "Sovereign default risk and state-dependent twin deficits," Journal of International Money and Finance, Elsevier, vol. 48(PB), pages 357-382.
    9. Bi, Huixin & Shen, Wenyi & Yang, Shu-Chun S., 2016. "Fiscal limits in developing countries: A DSGE Approach," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 119-130.
    10. 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.).
    11. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
    12. Christos Shiamptanis, 2017. "Austerity Measures: Do they avert solvency crises?," LCERPA Working Papers 0103, Laurier Centre for Economic Research and Policy Analysis, revised 19 Jun 2017.
    13. Wildmer Daniel Gregori & Wildmer Agnese Sacchi, 2016. "Has the Grexit news spilled over into euro area financial markets? The role of domestic political leaders, supranational executives and institutions," Mo.Fi.R. Working Papers 134, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
    14. Checherita-Westphal, Cristina & Žďárek, Václav, 2017. "Fiscal reaction function and fiscal fatigue: evidence for the euro area," Working Paper Series 2036, European Central Bank.
    15. Kriwoluzky, Alexander & Müller, Gernot J. & Wolf, Martin, 2015. "Exit Expectations and Debt Crises in Currency Unions," IWH Discussion Papers 18/2015, Halle Institute for Economic Research (IWH).
    16. Daniel, Betty C., 2014. "A graceful return of the drachma," European Economic Review, Elsevier, vol. 71(C), pages 228-243.
    17. Betty Daniel, Christos Shiamptanis, 2015. "Predicting Sovereign Fiscal Crises: High-Debt Developed Countries," LCERPA Working Papers 0090, Laurier Centre for Economic Research and Policy Analysis, revised 05 May 2015.
    18. repec:wlu:lcerpa:wm0070 is not listed on IDEAS

    More about this item

    Keywords

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

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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