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Fiscal Policy Coordination in a Monetary Union at the Zero-Lower-Bound

Author

Listed:
  • J. BOUSSARD

    (Insee)

  • B. CAMPAGNE

    (DG-Trésor)

Abstract

Following the Great Recession, Eurozone governments faced adverse economic environments: high public debt to GDP ratios, depressed outputs and the prospect of monetary policy hitting the zero-lower-bound (ZLB). The goal of this paper is to assess how stronger cross-region fiscal policy spillovers arising from constrained monetary policy may lead to different strategic interactions. This paper also offers a detailed analysis of the fiscal policy trade-offs the Eurozone faced when monetary policy became constrained. Using the Mélèze fiscal DSGE model developed at the Insee and estimating structural shocks to replicate the conditions where, absent any additional shock, the Eurozone economy would have been stuck at the ZLB for three years starting in 2013, we show that cross-border spillovers from fiscal policy are substantially higher without monetary offset. Increasing with the size of fiscal consolidation measures, they can amount up to a sixth of the domestic impact in the case of spending-based consolidations, and to almost half of the domestic impact in the case of VAT-based consolidations. Outside the ZLB, there are gains from fiscal coordination across countries as expansion in one region benefits less to the whole union than for the region undergoing expansion due to the reaction of monetary policy. As such, cooperation tends to limit fiscal expansion, even in a static setting that does not take into account issues of rule credibility nor time inconsistency. At the ZLB however, monetary policy being constrained, national objectives tend to be closer and the coordinated policy is less consolidating. Moreover, cooperation encourages symmetric rather than asymmetric policies.

Suggested Citation

  • J. Boussard & B. Campagne, 2017. "Fiscal Policy Coordination in a Monetary Union at the Zero-Lower-Bound," Documents de Travail de l'Insee - INSEE Working Papers g2017-05, Institut National de la Statistique et des Etudes Economiques.
  • Handle: RePEc:nse:doctra:g2017-05
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    References listed on IDEAS

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    Cited by:

    1. Ad van Riet, 2018. "The European Central Bank as the Only Game in Town: How Could Fiscal Policy Makers Play Along?," Credit and Capital Markets, Credit and Capital Markets, vol. 51(1), pages 93-111.

    More about this item

    Keywords

    DSGE model; monetary union; ZLB; fiscal policy; coordination;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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