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Smoothing shocks and balancing budgets in a currency union

Listed author(s):
  • James Costain

    ()

    (Banco de España)

  • Beatriz de Blas

    (Universidad autónoma de Madrid)

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
File Function: First version, January 2012
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Paper provided by Banco de España & Working Papers Homepage in its series Working Papers with number 1207.

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Length: 56 pages
Date of creation: Jan 2012
Handle: RePEc:bde:wpaper:1207
Contact details of provider: Web page: http://www.bde.es/

Web page: http://www.bde.es/bde/en/secciones/informes/Publicaciones_se/docs/
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  1. Willem H. Buiter, 2007. "Is Numerairology the Future of Monetary Economics? Unbundling numeraire and medium of exchange through a virtual currency and a shadow exchange rate," NBER Working Papers 12839, National Bureau of Economic Research, Inc.
  2. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
  3. Mark Gertler & Luca Sala & Antonella Trigari, 2008. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1713-1764, December.
  4. Eric M. Leeper, 2009. "Anchoring fiscal expectations," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 72, pages 17-42, September.
  5. Xavier Debrun & David Hauner & Manmohan S. Kumar, 2009. "Independent Fiscal Agencies," Journal of Economic Surveys, Wiley Blackwell, vol. 23(1), pages 44-81, 02.
  6. Tatiana Kirsanova & Simon Wren‐Lewis, 2012. "Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," Economic Journal, Royal Economic Society, vol. 122(559), pages 238-264, 03.
  7. 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).
  8. Barry Eichengreen & Ricardo Hausmann & Jürgen Von Hagen, 1999. "Reforming Budgetary Institutions in Latin America: The Case for a National Fiscal Council," Open Economies Review, Springer, vol. 10(4), pages 415-442, October.
  9. Bruche, Max & Suarez, Javier, 2010. "Deposit insurance and money market freezes," Journal of Monetary Economics, Elsevier, vol. 57(1), pages 45-61, January.
  10. Lars Calmfors, 2003. "Fiscal Policy to Stabilise the Domestic Economy in the EMU: What Can We Learn from Monetary Policy?," CESifo Economic Studies, CESifo, vol. 49(3), pages 319-353.
  11. Simon Wren-Lewis, 2011. "Comparing the delegation of monetary and fiscal policy," Economics Series Working Papers 540, University of Oxford, Department of Economics.
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