Working Paper: CEPR ID: DP12600
Authors: Roel Beetsma; Simone Cima; Jacopo Cimadomo
Abstract: Recent debate has focused on the introduction of a central stabilisation capacity as a completing element of the Economic and Monetary Union. Its main objective would be to contribute cushioning country-specific economic shocks, especially when national fiscal stabilisers are run down. There are two main potential objections to such schemes proposed so far: first, they may lead to moral hazard, i.e. weaken the incentives for sound fiscal policies and structural reforms. Second, they may generate permanent transfers among countries. Here we present a scheme that is relatively free from moral hazard, because the transfers are based on changes in world trade in the various sectors. These changes can be considered as largely exogenous, hence independent from an individual government’s policy; therefore, the scheme is better protected against manipulation. Our scheme works as follows: if a sector is hit by a bad shock at the world market level, then a country with an economic structure that is skewed towards this sector receives a (one-time) transfer from the other countries. The scheme is designed such that the transfers add up to zero each period, hence obviating the need for a borrowing capacity. We show that the transfers generated by our scheme tend to be countercyclical and larger when economies are less diversified. Cumulated over time, a country’s transfers generally tend to stabilise and to move towards zero, thus suggesting that permanent transfers are inherently ruled out under this scheme. Finally, we show that transfers are quite robust to revisions in the underlying export data.
Keywords: EMU; central fiscal capacity; exports; moral hazard
JEL Codes: E32; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sector-specific shocks in world trade (F19) | Transfers to countries specialized in those sectors (F16) |
| Transfers to countries specialized in those sectors (F16) | Cushioning country-specific economic shocks (F32) |
| Transfers (F16) | Mitigating moral hazard (G52) |
| Transfers are countercyclical (H87) | Transfers increase when economies are underperforming (F16) |
| Cumulative transfers stabilize over time (D15) | Permanent transfers are ruled out (F16) |
| Transfers are robust to revisions in underlying export data (F16) | Reliability in proposed mechanism (C59) |