Alexandre Lucas Cole, Chiara Guerello & Guido Traficante (2023), Government debt deleveraging in the EMU, International Economics, Volume 173, May 2023, Pages 296-324, https://doi.org/10.1016/j.inteco.2023.01.002

Abstract:
We evaluate the stabilization properties of several rules and instruments to reduce government
debt in a Currency Union, like the EMU. In a two-country New-Keynesian DSGE model, with
a debt-elastic government bond spread and incomplete international financial markets, we
study the effects of government debt deleveraging, under different scenarios for fiscal policy
coordination. We find that greater stabilization is achieved when the two countries coordinate
by stabilizing net exports. Moreover, we find that taxes are a better instrument for deleveraging
compared to government transfers. Our policy prescriptions for the Euro Area are to reduce
government debt less during recessions and liquidity traps, and to do so using distortionary
taxes, while concentrating on reducing international demand imbalances.

Published version: https://authors.elsevier.com/a/1gWFb7VwmARHpL
Free access pre-print version: https://mpra.ub.uni-muenchen.de/116000/1/MPRA_paper_116000.pdf

Thomas Davoine & Matthias Molnar (2020), Cross-country fiscal policy spillovers and capital-skill complementarity in integrated capital markets, Economic Modelling, Volume 88, 2020, Pages 132-150, ISSN 0264-9993, https://doi.org/10.1016/j.econmod.2019.09.014.

Abstract

The 2010 European sovereign debt crisis has renewed discussions on fiscal policy coordination. One rationale for coordination is fiscal policy cross-country spillovers. A common finding in the literature is that spillovers tend to be small in normal circumstances but can be large if monetary policy is at the zero lower bound. Orthogonal to the existing literature, we document a novel channel that generates cross-country spillovers over the medium run. We assume perfect capital markets integration and find that capital-skill complementarity can lead to large spillovers without the zero lower bound nor a large import share in government expenditures. As capital markets have become increasingly integrated in the Eurozone, the current degree of fiscal policy coordination between its members, low, may be insufficient. We also find that the smoothing benefits from a temporary rise in public debt spill over to other countries.

Cole, A., Guerello, C., & Traficante, G. (n.d.). ONE EMU FISCAL POLICY FOR THE EURO. Macroeconomic Dynamics, 1-41. Published online by Cambridge University Press: 26 November 2019. doi:10.1017/S1365100518000925.

Abstract

We build a two-country New-Keynesian DSGE model of a Currency Union to study the effects of fiscal policy coordination, by evaluating the stabilization properties and welfare implications of different fiscal policy scenarios. Our main findings are that a government spending rule which targets the net exports gap rather than the domestic output gap produces more stable dynamics and that consolidating government budget constraints across countries with symmetric tax rate movements provides greater stabilization. A key role is played by the trade elasticity which determines the impact of the terms of trade on net exports. In fact, when goods are complements, the stabilization properties of coordinating fiscal policies are no longer supported. These findings point out to possible policy prescriptions for the Euro Area: to coordinate fiscal policies by reducing international demand imbalances, either by stabilizing trade flows across countries or by creating some form of Fiscal Union or both.

An Open Access version is available at MPRA

An IHS policy brief on long run consequences of a capital market union in the European Union published. Read the policy brief here.

Also, some results of the FIRSTRUN project have been reported by Die Presse (in German).

A program library designed to model the EU’s fiscal rules is now available. The library includes a (stochastic) simulation model that can be used to solve the minimum fiscal effort under the EU’s new fiscal rules. The simulation model is applied by Kuusi (2017, Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance).

Download the library here:
https://www.dropbox.com/s/oyk4x55xtu7tdnm/EUrulesimulator.zip?dl=0

Instructions are available inside the zipped package. The library is designed to run on MATLAB.

The program library is also available at the Zenodo repository.

Iain Begg: The EU budget after 2020. European Policy Analysis 2017:9. Swedish Institute for European Policy Studies.

Abstract
The EU will need to begin soon to negotiate a new Multi-annual Financial Framework (MFF), to run from 2021, for the EU budget. The backdrop to the forthcoming negotiations is, self-evidently, very different because of Brexit, but also the many other pressures for reform, both of the budget itself and the Union more generally. This briefing paper explores the direct consequences of Brexit for EU resources as well as the wider ramifications of the departure of an influential Member State. Drawing on various recent contributions to the debate on the future of Europe, such as the European Commission White Paper and Jean-Claude Juncker’s 2017 State of the Union address to the European Parliament, it reviews likely demands for reform of the budget and how they might be accommodated in the next MFF. Three scenarios for the development of the EU’s finances are then set out, covering the status quo, moderate reform and the (admittedly implausible) prospect of a radical reconfiguration of public finances in the EU. Conclusions and predictions about likely outcomes complete the paper.

Download the paper here.

A new FIRSTRUN working paper “Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance” has been published today.

Abstract:
The EU’s new fiscal framework is complex. It includes multiple rules and target measures that steer fiscal policy both in the short and long term. While the complexity may be necessary, it is not without problems, as ambiguous fiscal rules are hard to communicate, implement, and enforce. To provide more clarity, this paper uses a dynamic simulation model to quantify the constraint that the rules impose on fiscal policy during consolidations. In particular, the simulator quantifies multiyear adjustment programs that minimize the need of fiscal adjustments while being compliant with the key elements of the framework. By using the European Sovereign Debt Crisis data, the paper shows that the model is consistent with the actual consolidation programs. The paper also finds that revisions of the economic forecasts have a large effect on the simulated adjustments and may increase policy volatility. The positive early 2010 forecasts imply faster minimum adjustments than the weaker ex-post economic data. This feature corresponds well with the recent slowdown of the member states’ fiscal adjustments, and suggests that the policy change is in compliance with the rules.

Author: Tero Kuusi (ETLA)

A program library designed to model the EU’s fiscal rules is now available. The library includes a (stochastic) simulation model that can be used to solve the minimum fiscal effort under the EU’s new fiscal rules.

Download the library here:
https://www.dropbox.com/s/oyk4x55xtu7tdnm/EUrulesimulator.zip?dl=0

Instructions are available inside the zipped package. The library is designed to run on MATLAB.

A new policy brief by Thomas Davoine (IHS) has been published in the journal Wirtschaftspolitische Blätter.

Abstract:
The rationale for fiscal policy coordination within the European Union during normal times is weak because cross-country fiscal policy spillovers are found to be small. During crises, spillovers are larger, either because of constraints on monetary policy or because capital markets are well integrated. With a multi-country general equilibrium model assuming perfect capital market integration, I quantify the medium run impact of foreign fiscal actions on Austria. For instance, if Germany is hit by a negative shock and bails out its private sector, the predicted yearly average GDP loss in Austria is 15% of the yearly GDP loss in Germany. Bailouts in smaller European countries lead to weaker spillovers.

Read the full policy brief here

A new research paper by Thomas Davoine and Matthias Molnar (IHS) has been published:

Thomas Davoine & Matthias Molnar: Cross-country fiscal policy spillovers and capital-skill complementarity in currency unions. IHS Economics Series, Working Paper No. 329.

Abstract:
We investigate cross-country fiscal policy spillovers through the integration of capital markets in a currency union and allow capital use in production to differ across countries. Following empirical evidence, we assume that production exhibits capital-skill complementarity. Using a multi-country overlapping-generations model calibrated for 14 European Union countries, we find that output spillovers are small with standard tax reforms but can be sizeable with large government spending increases financed by taxes: long run output losses in shock-free countries can amount to a quarter of the losses in countries hit by the spending shock. Conditional and temporary relaxing of the EU debt ceiling rule could benefit the Union as a whole.

The current issue of the National Institute Economic Review* features several articles by FIRSTRUN researchers.

Simon Kirby (NIESR):
Economic Policy and Surveillance in Europe: Introduction

Iain Begg (LSE):
Fiscal and Other Rules in EU Economic Governance: Helpful, Largely Irrelevant or Unenforceable?

Tero Kuusi (Etla):
Does the Structural Budget Balance Guide Fiscal Policy Pro-Cyclically? Evidence from the Finnish Great Depression of the 1990s

Tomáš Domonkos, Filip Ostrihon, Ivana Šikulová, Mária Širanová (IER):
Analysing the Relevance of the MIP Scoreboard’s Indicators

Also see a related article by Jan in’t Veld (DG ECFIN):
A Public Investment Stimulus in Surplus Countries and Its Spillovers in the EA

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*) The National Institute Economic Review is the quarterly publication of the National Institute of Economic and Social Research, one of Britain’s oldest and most prestigious independent research organisations.

National Institute Economic Review, founded in 1959, provides a vehicle for publishing and promoting high quality research and debate on economic and related social issues.

National Institute Economic Review, Volume 239, Issue 1, February 2017.