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One EMU Fiscal Policy for the EURO

Author

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  • Alexandre Lucas Cole

    () (LUISS "Guido Carli" University)

  • Chiara Guerello

    () (LUISS "Guido Carli" University)

  • Guido Traficante

    () (European University of Rome)

Abstract

We build a Two-Country Open-Economy New-Keynesian DSGE model of a Currency Union to study the effects of fiscal policy coordination, by evaluating the stabilization properties of different degrees of fiscal policy coordination, in a setting where the union-wide monetary policy affects fiscal policies and viceversa, because of price rigidities and distortionary taxation. We calibrate the model to represent two groups of countries in the European Economic and Monetary Union and run numerical simulations of the model under a range of alternative shocks and under alternative scenarios for fiscal policy. We also compare welfare under the different scenarios, bringing to policy conclusions for the proper macroeconomic management of a Currency Union. We find that: a) coordinating fiscal policy by targeting net exports, rather than output, produces more stable dynamics, b) consolidating government budget constraints across countries and moving tax rates jointly provides greater stabilization, c) taxes on wage income are exponentially more distortionary than taxes on firm sales. Our policy prescriptions for the Eurozone are then to use fiscal policy to reduce international demand imbalances, either by stabilizing trade fl ows across countries or by creating some form of fiscal union or both, while avoiding the excessive use of labour taxes, in favour of sales taxes.

Suggested Citation

  • Alexandre Lucas Cole & Chiara Guerello & Guido Traficante, 2016. "One EMU Fiscal Policy for the EURO," Working Papers CELEG 1602, Dipartimento di Economia e Finanza, LUISS Guido Carli.
  • Handle: RePEc:lui:celegw:1602
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    References listed on IDEAS

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    Cited by:

    1. Alexandre Lucas Cole & Chiara Guerello & Guido Traficante, 2016. "Government Debt Deleveraging in the EMU," Working Papers CELEG 1603, Dipartimento di Economia e Finanza, LUISS Guido Carli.

    More about this item

    Keywords

    Fiscal Policy; International Policy Coordination; Monetary Union; New Keynesian.;

    JEL classification:

    • 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
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory

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