Working Paper: CEPR ID: DP18279
Authors: Francesco Bianchi; Leonardo Melosi; Anna Rogantini Picco
Abstract: The current Euro Area policy framework exposes its members to the opposite risks of deflation and high inflation because it does not separate the need for short-run macroeconomic stabilization from the issue of long-run fiscal sustainability. We study a new policy framework that addresses this deficiency. A centralized Treasury issues Eurobonds to finance stabilization policies, while national governments remain responsible for the country-level long-term spending programs. The centralized Treasury can run larger primary deficits during recessions, followed by primary surpluses during expansions. However, following an exceptionally large contractionary shock, the centralized Treasury can coordinate with the monetary authority to reflate the economy and avoid the zero lower bound. The policy acts as an automatic stabilizer and removes the risk of deflation. At the same time, the proposed policy framework removes the risk of high inflation and fiscal stagflation because it does not require suspending the fiscal rules designed to preserve long-run fiscal sustainability.
Keywords: monetary and fiscal policy coordination; eurobonds; zero lower bound
JEL Codes: E50; E62; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| centralized treasury issuing eurobonds (H63) | stabilization policies during recessions (E63) |
| centralized treasury issuing eurobonds (H63) | mitigates the risk of deflation (E31) |
| larger primary deficits during recessions (E62) | stabilization during expansions (E63) |
| structure of fiscal framework (H68) | stabilize inflation rates (E63) |
| coordinated policies (F42) | enhance economic stability (E60) |