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Can Countries under A Common Currency Conduct Their Own Fiscal Policies?

  • Alex Izurieta

    (Levy Economics Inst)

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    The debate about balance of payment problems is generally linked with adjustments in the fiscal sector, especially since the views of Bretton Woods institutions became predominant. For the majority of theoretical models that currently inform policy, it is becoming common thought that in a world of free trade and free movement of capital, a floating rate of exchange may clear the market for financial assets. In these models, the persistence of balance of payment problems can be attributed to rigidities either in the fiscal sector (that is, the inability of the public sector to run a balanced budget), or the labor market (that is, trade union pressures and welfare protective measures leading to uncompetitive salaries). This approach, which makes the fiscal stance the culprit of macroeconomic imbalances in countries with floating exchange rates, is, however, also applied to countries that have adopted other, more rigid forms of exchange rate policy, such as currency boards, dollarization, and common currency agreements. It seems to be overlooked that systems of common currency pose problems of an entirely different kind because two major mechanisms of macroeconomic adjustment ¾ exchange rate flexibility and money issuing ¾ are obviously removed. Thus, theoretical and policy-oriented propositions need to take into account this new set of restrictions.

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    Paper provided by EconWPA in its series Macroeconomics with number 0108008.

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    Length: 13 pages
    Date of creation: 04 Sep 2001
    Date of revision:
    Handle: RePEc:wpa:wuwpma:0108008
    Note: Type of Document - Adobe Acrobat PDF; prepared on IBM PC; to print on PostScript; pages: 13; figures: included
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