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Fiscal Policy, intercountry adjustment and the real exchange rate within Europe

  • Christopher Allsopp
  • David Vines

In EMU, a country may have difficulty ensuring stability in the face of asymmetric shocks; the response may be unstable, or, even if not, the real exchange rate might overshoot. Fiscal policy may help to stabilise inflation and also to target the real exchange rate. The paper argues that an improved fiscal policy process might result in improved macroeconomic performance within Europe. Within EMU, a country may have difficulty ensuring stability in the face of asymmetric shocks; the response may be unstable, or, even if not, the real exchange rate might overshoot. In this context, the rules of the SGP may interfere with the control of inflation control, with the short-run stabilisation of demand, and also with the longer term adjustment of intra-European real exchange rates. We recommend using fiscal policy to stabilise inflation and also to target the real exchange rate rather than deficits or debt. Such a policy would require a more active use of fiscal policy.

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File URL: http://ec.europa.eu/economy_finance/publications/publication13258_en.pdf
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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 344.

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Length: 41 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:euf:ecopap:0344
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