Working Paper: CEPR ID: DP3035
Authors: Roel Beetsma; Xavier Debrun; Franc Klaassen
Abstract: It is widely argued that Europe's unified monetary policy calls for international coordination at the fiscal level. We survey the issues involved with such coordination of fiscal policy as a demand management tool and we use a simple model to investigate the circumstances under which coordination may be desirable. It turns out that coordination is beneficial when the correlation of the shocks hitting the various economies is low. Given the potentially adverse reaction by the ECB (as a result of free-riding and/or a conflict on the orientation of the policy mix), fiscal coordination is likely to be counterproductive when demand or supply shocks are highly symmetric across countries and governments are unable to acquire a strategic leadership position vis-à-vis the ECB. Generally, the scope for fiscal coordination is larger under asymmetric shocks, because the ECB remains passive as average inflation in the union is unaffected. This result contrasts with the more widely held view that the case for international fiscal coordination is strongest under common shocks.
Keywords: demand management; EMU; fiscal coordination; shocks
JEL Codes: E52; E58; E61; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy coordination is desirable when the correlation of economic shocks across countries is low (F42) | Effective national fiscal interventions without impacting overall inflation (E62) |
| Fiscal coordination is likely to be counterproductive when demand or supply shocks are highly symmetric across countries (F42) | Increased free-riding behavior among governments (H40) |
| Increased free-riding behavior among governments (H40) | Greater burden on the ECB to manage inflation (E52) |
| Greater burden on the ECB to manage inflation (E52) | Conflict over policy orientation (D74) |
| Fiscal coordination may magnify the free-riding behavior of the ECB (F42) | National governments bear a disproportionate share of the stabilization burden during symmetric demand shocks (E63) |
| National governments bear a disproportionate share of the stabilization burden during symmetric demand shocks (E63) | Increased fiscal activism that may not yield intended stabilizing effects (E62) |
| Increased fiscal activism that may not yield intended stabilizing effects (E62) | Social costs that outweigh the benefits of coordination (D61) |
| Governments engage in binding precommitments (D72) | First-mover advantage (D43) |
| First-mover advantage (D43) | Shift the stabilization burden onto the ECB (E63) |
| Shift the stabilization burden onto the ECB (E63) | Enhanced desirability of coordination (E61) |