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ONE EMU FISCAL POLICY FOR THE EURO

Published online by Cambridge University Press:  26 November 2019

Alexandre Lucas Cole
Affiliation:
PBO (UPB) and LUISS Guido Carli
Chiara Guerello
Affiliation:
LUISS Guido Carli
Guido Traficante
Affiliation:
European University of Rome
Corresponding
E-mail address:

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.

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© 2019 Cambridge University Press

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Footnotes

We thank William A. Barnett (editor) and two anonymous referees for valuable comments on an earlier draft. A special thanks to Pierpaolo Benigno for useful research guidance and to Giovanna Vallanti for helpful academic guidance. We would like to thank Konstantinos Tsinikos, Pietro Reichlin, Andrea Ferrero, Tommaso Trani, Niku Määttänen, and participants in LUISS Guido Carli seminars, the FIRSTRUN Workshop of September 26th 2016 and the 12th Dynare Conference for useful comments and suggestions. All errors are our own. The views and opinions expressed in this paper are those of the authors and do not necessarily reflect the official policy or position of any other agency, organization, employer, or company. We acknowledge financial support through the research project FIRSTRUN (www.firstrun.eu) (Grant Agreement No. 649261) funded by the Horizon 2020 Framework Programme of the European Union.

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