Designing Fiscal Institutions in a Monetary Union

This article explores the policy and wealth consequences of alternative institutional arrangements through which fiscal policy interacts with monetary policy in a monetary union such as the EMU. The central issue of the article is the design of the appropriate monetary and fiscal institutions through a comparison of alternative arrangements to distribute power over monetary and fiscal authorities between the central authority of the union and the individual members of the union and evaluating their performance. The main results of this article reveal that delegation of the fiscal policy to a council of country representatives and the monetary policy to a council of governors is the appropriate institutional design to reduce inflation bias and better stabilize regional, idiosyncratic supply and demand shocks in a monetary union.     

Cooperative Monetary and Fiscal Policies in the Euro Area

This article discusses the interaction of fiscal and monetary policy in the euro area. Though many observers suggest a fiscal union as the next step of euro-area constitutional reform, a federal fiscal union does not appear politically feasible in the short run. We suggest moving forward with cooperative monetary and fiscal institutions and policies that allow for decentralized fiscal decisions, while taking federal stabilization policies into account. This approach will increase the probability of survival of the euro area compared with the current fiscal arrangements. Using a dynamic macro model, counterfactual simulation paths of our cooperative solution are contrasted with time-series data for the euro area.     

Monetary and Fiscal Policy Design in the EMU: An Overview

The interaction of monetary and fiscal policies is a crucial issue in a highly integrated economic area such as the European Union. This paper analyzes the design of monetary and fiscal policies in the EMU. To do so, the paper starts with an overview of the most important aspects. Next, it analyzes monetary and fiscal policy interaction in a stylized model of a monetary union, in which monetary and fiscal policy design is modeled as a dynamic stabilization game. Macroeconomic policy making and adjustment are studied under alternative forms of cooperation and in both symmetric and asymmetric settings.     

Uncertainty and Fiscal Policy in an Asymmetric Monetary Union

We examine monetary and fiscal interactions in a monetary union model with uncertainty due to imperfect central bank transparency. It is first shown that monetary uncertainty discourages excessive taxation and may thus reduce average inflation and output distortions. However, as countries enter the monetary union, this tax-restraining effect of uncertainty is mitigated. The monetary union may hence lead to higher fiscal distortions in some member countries, depending on governments’ spending targets and on the change in the degree of uncertainty implied by common monetary policy.     

Estimating local fiscal multipliers using political connections

We use political connections between central and local governments in China to identify the effects of government spending. Our key innovation is using changes of central government ministers as a source of exogenous variation in earmarked transfers received by prefectural city-level governments. The analysis reveals that the increase in earmarked transfers is temporary and local effective tax rates do not respond to such fiscal expansions. Given that using cross-regional analysis for a monetary union can difference out the influence of monetary policy, the fiscal shock we study is a temporary, non-tax financed and no-monetary-policy-response government spending shock. We find the local fiscal multiplier in China is above one and there are no significant spillover effects from local government spending.     

The Performance of Simple Fiscal Policy Rules in Monetary Union

The paper analyses the stabilising potential of simple fiscal policy rules for a small open economy in monetary union in a 2-region DSGE model with nominal and real rigidities. We consider simple fiscal instrument rules for government purchases, transfers, and consumption, labour and capital taxes in analogy to interest rate rules in monetary policy. The paper finds a dichotomy in the welfare effects of fiscal policy for liquidity-constrained and intertemporal optimising households, i.e. policies enhancing the welfare of one group tend to reduce the welfare of the other one. The moderate average welfare gains from optimal policy contrast with potentially large welfare losses from non-optimal policy. Fiscal rules that respond to employment fluctuations may be preferred to fiscal rules responding to indicators of price competitiveness, because optimal policy corresponds more closely to the idea of countercyclical stabilisation in the former case. The simulations also emphasise the crucial impact of the budgetary closure rule on the welfare consequences of fiscal business-cycle stabilisation.     

EMU Stability: Direct and Indirect Risk Sharing

Our paper aims to analyze the effectiveness of different risk-sharing mechanisms in providing stability to a monetary union. We select two stylized tools with extreme and opposite features. The first is an expansionary but conventional monetary policy that is used to help EMU’s most fragile member states manage their public debts; the second is a centralized fiscal policy that allows for the transfer of a portion of these public debts from EMU’s most fragile member states to those considered EMU’s “core”. By a stylized periphery-core model of a monetary union, we compare the strengths and weaknesses of these two tools in order to reach some welfare implications in terms of union stability.     

European monetary unification: a tour d'horizon

This article takes stock of the literature and debate over Europeanmonetary unification. In contrast to other papers, where itis argued that the issues and prospects remain shrouded in uncertainty,I argue that in a number of important areas, a reasonable degreeof consensus now exists, as the result of a decade of scholarship.The subsequent stock-taking concentrates on areas where significantquestions remain, starting with the implications of surrenderingthe exchange rate and an independent national monetary policyas instruments of adjustment; the conduct of fiscal policy underthe Excessive Deficit Procedure and the Stability Pact; andhow quickly the European union is likely to develop an EU-widesystem of fiscal federalism to accompany its monetary union.Turning from fiscal to monetary issues, I ask whether the EuropeanCentral Bank (ECB) will be as inflation averse as the Bundesbank,what exchange-rate policy the ECB will pursue, and whether theeuro will be a leading reserve currency. I conclude with whatmay be the most contentious issue of all, namely whether Europe'smonetary union could collapse after it begins.     

Monetary Union in West Africa: An Agency of Restraint for Fiscal Policies?

Could a monetary union in West Africa (either an informal monetaryunion of the non-CFA countries, or a possible future monetaryunion of all ECOWAS members) be an effective ‘agency ofrestraint’ (Collier, 1991) on fiscal policies? We discussthe ways, both positive and negative, that monetary union couldaffect fiscal discipline and the arguments for explicit fiscalrestraints considered in the literature about the European MonetaryUnion (EMU), and consider their applicability to West Africa.The empirical evidence, EMU literature and CFA experience allsuggest the possibility that monetary union could create thetemptation for fiscal profligacy through prospects of a bail-out,or costs that are diluted through the membership. We concludethat a monetary union in West Africa can be an effective agencyof restraint on fiscal policies only if the hands of the fiscalauthorities are also tied by a strong set of fiscal restraintcriteria, applicable not just for accession to monetary union,but throughout the life of the union.     

Transatlantic Trade-Offs in the Age of Balanced Budgets and European Monetary Union

We develop a model of monetary and fiscal policies appropriate for considering U.S.-European policy interactions in an era of near-balanced budgets and European monetary union. We study the determinants of policy trade-offs and incentives for central banks and governments across the Atlantic. Smaller, more open economies face more favorable trade-offs, since openness enhances policy effectiveness via the exchange-rate channel. Changes in Europe's monetary arrangements do not affect U.S. trade-offs, although they alter the trade-offs facing European policy-makers. Fiscal trade-offs depend crucially on the extent to which fiscal policy is distortionary. Changes in taxes and spending move both employment and inflation in the desired direction following a worldwide supply shock when spending is financed with distortionary taxes.     

Monetary-fiscal policy assignment under floating exchange rates

Summary This paper examines the use of monetary and fiscal policy in a small country model under floating exchange rates. The government attempts to achieve a target level of economic activity and either an investment spending (output composition) or current account target. However, a choice may have to be made between the latter two objectives because a trade-off exists between them as the monetary-fiscal policy mix changes. It is shown that either monetary or fiscal policy can be assigned to the GNP target, and the second policy to one of the other targets, although the path may be oscillatory.The author is grateful to the referee for helpful comments but must absolve him from all remaining errors.     

Brussels on a single money

This review article discusses the recent document titled “One Market, One Money” in which the European Commission develops its case for European monetary union. After examining the monetary issues as such, the article focuses on the reasons for the Commission's very worried attitude about fiscal policy autonomy. The closing section considers the problem of the transition to a single money. Attention is also called to the issue of a lender of last resort.     

Rotating Slumps in a Monetary Union

In the decade since its creation in 1999, the European Economic and Monetary Union (EMU) has experienced surprisingly large and persistent inflation differentials across member states causing substantial shifts in relative price levels. At the same time, member countries exhibited distinct non-synchronized output fluctuations, giving rise to a pattern of ‘rotating slumps’ (a term coined by Olivier Blanchard). This paper presents a stylized theoretical model of a monetary union which demonstrates how inflation differentials and relative output movements interact dynamically. A number of implications are derived from the model. In particular, national fiscal policies are shown to have an important role in containing internal macroeconomic disparities in a monetary union. An optimal fiscal policy rule is derived from the model for that purpose.     

Is there a trade-off between free capital mobility,financial stability and fiscal policy flexibility in the EMU?

The recent dynamics characterizing the Eurozone economy suggest the existence of a new policy trilemma faced by its member countries. According to this policy trilemma, there is a trade-off between free capital mobility, financial stability and fiscal policy flexibility. In this paper, we analyze the foundations of such a trade-off and, based on the data for 11 Eurozone countries, present an empirical investigation on the existence of the trilemma. The results highlight the existence of the trade-off, with some differences between member countries. The existence of this trilemma in the Eurozone provides arguments for implementing centralized financial supervision together with fiscal and monetary reforms that should strengthen the currency union.     

Monetary Unions in Historical Perspective: What Future for the Euro in the International Financial System

This paper discusses the introduction of the euro in the present international monetary context. European Monetary Union is not only an economic concept but also primarily a political one. Based on past experience, two aspects of monetary union seem essential: the nature of the future European Central Bank and the necessity that monetary union is implemented with a fiscal union. The euro's success on world markets, as a dollar substitute, depends on monetary authorities' credibility in targeting low-inflation, and on fiscal authorities' reputation. A central bank that does not respond to a political authority can cause social difficulties, especially if social policies are left in the hands of single countries and fiscal transfers, to support these policies, are not allowed     

Multiple wage-bargaining systems in the single European currency area

Little attention in the EMU literature has been paid to theinteraction between central bank monetary rules and systemsof collective wage bargaining. Analytically and empirically,coordinated wage-bargaining systems respond with real wage restraintto non-accommodating monetary policy. Since wage determinationis dominated by collective bargaining in all the EMU memberstates and wage coordination within the member states has grownsince 1980, this is a topic of potential importance. In particular,the replacement of the Bundesbank, directly targeting Germaninflation, by a European Central Bank (ECB) targeting Europeaninflation will remove a major institutional support of wagerestraint in Germany. The consequences of this for EMU are workedout under two scenarios, that inflation expectations will begenerated by ECB monetary policy and that they will reflectGerman inflation outcomes. Possible institutional developmentsare discussed including government union bargains. The Bundesbankalso played a major role in maintaining fiscal rectitude: forunderlying structural reasons, therefore, it is possible thatGermany will move to a period of fiscal activism with wage restraintand low inflation purchased through social contract negotiations.     

Delegation and Fiscal Policy in the Open Economy: More Bad News for Rogoff's Delegation Game

This article studies the open-economy Rogoff delegation game, taking into account both intra-country and intercountry interactions between fiscal authorities and central banks. With representative bankers, the Nash equilibrium of fiscal and monetary authorities independently responding to supply-side shocks sees insufficient monetary adjustment and an imbalance towards fiscal stabilization if shocks are sufficiently symmetric; the opposite occurs if shocks are sufficiently asymmetric. Appointing conservative bankers shifts the fiscal–monetary balance away from monetary towards fiscal policy. Unilateral delegation benefits that country; but when all countries independently delegate, the outcome is only favorable if shocks are sufficiently asymmetric.     

Fiscal Rules in a Monetary Union: A Short-Run Analysis

This article challenges the conventional result according to which an instrument-independent central bank able to strictly commit to price stability makes fiscal constraints unnecessary. We present a model of a monetary union with heterogeneous members where the inefficient policy mix resulting from the lack of coordination between the common monetary policy and national fiscal policies incites the governments to appoint excessively liberal delegates to the central bank's board. We characterize the fiscal restraints necessary to restore the central bank's ability to deliver the most desirable degree of price stability. It appears that even country-specific and state-contingent restraints may be counterproductive for some member states.     

Reserve requirements,currency substitution,and seigniorage in the transition to European monetary union

This article considers a transition toward European monetary union that combines increased substitution of currencies and greater monetary, financial, and fiscal policy coordination. It explores how such a transition would affect national inflation and interest rates and required reserve ratios when governments depend in part on seigniorage funding for public expenditures. We find that greater coordination of policies would lead to lower inflation and interest rates but higher reserve-requirement ratios. Because higher reserve-requirement ratios could place European banks at a competititve disadvantage, we conclude that the interaction between reserve requirements and seigniorage concerns makes it less likely that the gradualist approach of the Maastricht treaty is a sustainable means of transition to European union.     

Norway's liberalisation of trade and payments in the 1950s

Abstract

While historical scholarship has focused on the domestic macroeconomic adjustment to trade liberalisation of the 1950s in terms of fiscal, monetary and incomes policies, this study deals with the liberalisation itself. From the perspective of the domestic political economy it provides an account of Norway's policies towards the European trade and payments schemes. It argues that although national ambitions were constrained by multilateral European liberalisation, a successful policy mix of exploiting EPU credits, delaying import quota liberalisation and selectively raising tariffs was pursued. It also argues that the government's sympathy towards the stillborn Nordic customs union in 1954 originated in this policy mix.