Working Paper: CEPR ID: DP639
Authors: Andrew Brociner; Paul Levine
Abstract: This paper considers fiscal policy coordination in a European Economic and Monetary Union (EMU). We use an overlapping generations model which leads to departures from Barro-Ricardian neutrality. In our calibrated model, however, we find these departures to be rather small. Two models are considered: EMU with one good; and a two-good EMU. We find that in the two-good EMU model, as relative prices can change, countries have an incentive to improve their terms of trade. This externality together with increased real interest rates - shared by all EMU countries - leads to an inefficient outcome in the non-cooperative case. Thus fiscal policy coordination can lead to significant welfare gains. With government spending externalities, however, the negative externalities can offset positive ones arising from government spending, such as defence. Furthermore, in the one-good EMU model, cooperation can be counterproductive. We conclude that the case for fiscal policy coordination depends upon the nature of both the economic integration in Europe and the externalities from government spending.
Keywords: EMU; Fiscal Policy Coordination; Reputation; Ricardian Neutrality; Externality
JEL Codes: F15; F36; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy coordination (F42) | welfare gains (D69) |
| Fiscal policy coordination (F42) | negative externalities can offset welfare gains (D62) |
| Fiscal expansion (E62) | inefficient outcome in non-cooperative case (C72) |
| Government spending externalities (D62) | welfare is influenced by fiscal policy (H53) |
| Cooperation (C71) | counterproductive in one-good EMU model (E19) |
| Negative externalities (D62) | crowding out of investment due to increased real interest rates (E43) |