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EMU's Decentralized System of Fiscal Policy

  • Jürgen von Hagen
  • Charles Wyplosz

This paper reviews the macroeconomic use of national fiscal policy in EMU and examines the rational and scope for a collective insurance system which redistributes income among countries in response to asymmetric cyclical shocks. The analysis of the record of national fiscal policies before and after the adoption of the Maastricht Treaty finds evidence that the quality of fiscal policies has improved in two ways: they are more clearly countercyclical - or less procyclical - and they are more readily used to restore competitiveness than to attempt to boost demand when competitiveness is eroded. These observations suggest that fiscal policy remains a useful instrument. One question is whether it can be augmented - or perhaps substituted for - with a collective insurance system. Collective insurance is one alternative to external borrowing and lending and therefore one way to deal with the concerns that the SGP is meant to address. We examine in more detail two collective insurance systems: tax revenue sharing and unemployment insurance sharing. We find that the earlier is more promising and examine in some detail how it could be set up. It is no panacea, though. Any insurance mechanism entails moral hazard and that moral hazard can, at best, only be mitigated, not eliminated.

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Paper provided by Directorate General Economic and Financial Affairs (DG ECFIN), European Commission in its series European Economy - Economic Papers with number 306.

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Length: 25 pages
Date of creation: Feb 2008
Date of revision:
Handle: RePEc:euf:ecopap:0306
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  1. Giavazzi, Francesco & Jappelli, Tullio & Pagano, Marco, 2000. "Searching for Non-Linear Effects of Fiscal Policy: Evidence from Industrial and Developing Countries," CEPR Discussion Papers 2374, C.E.P.R. Discussion Papers.
  2. Krogstrup, Signe & Wyplosz, Charles, 2006. "A Common Pool Theory of Deficit Bias Correction," CEPR Discussion Papers 5866, C.E.P.R. Discussion Papers.
  3. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1329-1368, November.
  4. Alan C. Stockman, 1998. "New evidence connecting exchange rates to business cycles," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 73-89.
  5. Jordi Gali & Roberto Perotti, 2003. "Fiscal Policy and Monetary Integration in Europe," NBER Working Papers 9773, National Bureau of Economic Research, Inc.
  6. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  7. Roberto Perotti, 2007. "In Search of the Transmission Mechanism of Fiscal Policy," NBER Working Papers 13143, National Bureau of Economic Research, Inc.
  8. Xavier Sala-i-Martin & Jeffrey Sachs, 1991. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States," NBER Working Papers 3855, National Bureau of Economic Research, Inc.
  9. Bayoumi, Tamim & Masson, Paul R, 1994. "Fiscal Flows in the United States and Canada: Lessons for Monetary Union in Europe," CEPR Discussion Papers 1057, C.E.P.R. Discussion Papers.
  10. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2001. "Is the Price Level Determined by the Needs of Fiscal Solvency?," American Economic Review, American Economic Association, vol. 91(5), pages 1221-1238, December.
  11. Wyplosz, Charles, 1991. "Monetary Union and Fiscal Policy Discipline," CEPR Discussion Papers 488, C.E.P.R. Discussion Papers.
  12. Christina D. Romer & David H. Romer, 2007. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks," NBER Working Papers 13264, National Bureau of Economic Research, Inc.
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