ME  Vol.3 No.6 , October 2012
Discretionary Fiscal Policy and the European Monetary Union
Author(s) Jason Jones
ABSTRACT
A model of circumstances that can lead to changes in the way a fiscal authority conducts policy after joining a monetary union is presented and empirically tested for the euro area. According to the model consolidation fatigue, shock asymmetry, or differences in the relative weight placed on output/price stabilization between the new and old monetary authority can lead to greater reliance on fiscal policy. Empirical evidence suggests that there has been a change in the conduct of fiscal policy in the euro area which is most likely due to consolidation fatigue and a stronger emphasis on price stabilization by the European Central Bank.

Cite this paper
J. Jones, "Discretionary Fiscal Policy and the European Monetary Union," Modern Economy, Vol. 3 No. 6, 2012, pp. 742-751. doi: 10.4236/me.2012.36095.
References
[1]   H. Uhlig, “One Money, But Many Fiscal Policies in Europe: What are the Consequences,” CEPR Discussion Papers No. 3296, 2002.

[2]   A. H. Hallett and J. Lewis, “European Fiscal Discipline Before and After EMU: Crash Diet or Permanent Weight Loss,” Macroeconomic Dynamics, Vol. 12, No. 3, 2008, pp. 404-424.

[3]   P. Benigno, “Optimal Monetary Policy in a Currency Area,” Journal of International Economics, Vol. 63, No. 2, 2004, pp. 293-320. doi:10.1016/S0022-1996(03)00055-2.

[4]   R. Beetsma and H. Jensen, “Monetary and Fiscal Policy Interactions in a Micro-founded Model of a Monetary Union,” Journal of Macroeconomics, Vol. 26, No. 2, 2005, pp. 357-376. doi:10.1016/j.jmacro.2003.11.017.

[5]   J. Gali and T. Monacelli, “Optimal Monetary and Fiscal Policy in a Currency Union,” Journal of International Economics, Vol. 76, No. 1, 2008, pp. 116-132.

[6]   T. Michalak, J. Engwerda and J. Plasmans, “Strategic Interactions between Fiscal and Monetary Authorities in a Multi-Country New-Keynesian Model of a Monetary Union,” CESifo Working Paper, No. 2534, 2009.

[7]   A. Dixit and L. Lambertini, “Monetary-Fiscal Policy Interaction and Commitment versus Discretion in a Monetary Union,” European Economic Review, Vol. 45, No. 4-6, 2001, pp. 977-987. doi:10.1016/S0014-2921(01)00134-9.

[8]   A. Dixit and L. Lambertini, “Symbiosis of Monetary and Fiscal Policies in a Monetary Union,” Journal of International Economics, Vol. 60, No. 2, 2003, pp. 235-247. doi:10.1016/S0022-1996(02)00048-X.

[9]   R. Beetsma, X. Debrun and F. Klaassen, “Is Fiscal Policy Coordination in EMU Desirable,” CESifo Working Papers, No. 599, 2001.

[10]   B. Van Aarle, H. Garretsen and F. Huart, “Monetary and Fiscal Policy Rules in the EMU,” German Economic Review, Vol. 5, No. 4, 2004, pp. 407-434. doi:10.1111/j.1465-6485.2004.00115.x.

[11]   P. Bofinger and E. Mayer, “Monetary and Fiscal Policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve,” Open Economy Review, Vol. 18, No. 3, 2007, pp. 291-305. doi:10.1007/s11079-007-9039-3.

[12]   R. Beetsma and A. Bovenberg, “Monetary Union without Fiscal Coordination may Discipline Policymakers,” Journal of International Economics, Vol. 45, No. 2, 1998, pp. 239-258. doi:10.1016/S0022-1996(98)00031-2

[13]   R. Mundell, “A Theory of Optimal Currency Area,” American Economic Review, Vol. 51, No. 4, 1961, pp. 657-665.

[14]   C. Wyplosz, “European Monetary Union: The Dark Side of Major Success,” Economic Policy, Vol. 21, No. 46, 2006, pp. 207-261.

[15]   B. Eichengreen and C. Wyplosz, “The Stability Pact: More than a Minor Nuisance,” Economic Policy, Vol. 13, No. 26, 1998, pp. 65-113.

[16]   J. Gali and R. Perotti, “Fiscal Policy and Monetary Integration in Europe,” Economic Policy, Vol. 18, No. 37, 2003, pp. 533-572.

[17]   A. García, M. Arroyo, R. Minguez and J. Uxó, “Estimation of a Fiscal Policy Rule for EMU Countries,” Applied Economics, Vol. 41, No. 7, 2009, pp. 869-884.

[18]   J. Von Hagen, “Fiscal Rules and Fiscal Performance in the EU and Japan,” GESY Discussion Paper, No. 147, 2006.

[19]   F. Balassone, M. Francese and S. Zotteri, “Cyclical Asym- metry in Fiscal Variables in the EU,” Empirica, Vol. 37, No. 4, 2010, pp. 381-402. doi:10.1007/s10663-009-9114-7

[20]   B. Candelon, J. Muysken and R. Vermeulen, “Fiscal Policy and Monetary Integration in Europe: An Update,” Oxford Economic Papers, Vol. 62, No. 2, 2010, pp. 323- 349. doi:10.1093/oep/gpp017

[21]   M. Strawczynski and J. Zeira, “Cyclicality of Fiscal Policy: Permanent and Transitory Shocks,” CEPR Discussion Paper, No. DP271, 2009.

[22]   O. Blanchard and D. Quah, “The Dynamic Effects of Aggregate Demand and Supply Disturbances,” American Economic Review, Vol. 79, No. 4, 1989, pp. 655-673.

[23]   T. Bayoumi and B. Eichengreen, “Shocking Aspects of European Monetary Unification,” NBER Working Papers, No. 3949, 1992.

[24]   J. Fidrmuc and I. Korhonen, “Similarity of Supply and Demand Shocks between the Euro Area and the CEECs,” Economic Systems, Vol. 27, No. 4, 2003, pp. 313-336. doi:10.1016/j.ecosys.2003.05.002

[25]   J. Babetski, L. Boone and M. Maurel, “Exchange Rate Regimes and Supply Shock Asymmetry: The Case of the Accession Countries,” Journal of Comparative Economics, Vol.32, No. 2, 2004, pp. 212-229.

[26]   M. Arellano and S. R. Bond, “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations,” Review of Economic Studies, Vol. 58, No. 194, 1991, pp. 277-297. doi:10.2307/2297968

[27]   V. Chari, P. Kehoe and E. McGrattan, “Are Structural VaRs with Long-Run Restrictions Useful in Developing Business Cycle Theory,” Journal of Monetary Economics, Vol. 55, No. 8, 2008, pp. 1337-1352. doi:10.1016/j.jmoneco.2008.09.010

[28]   F. Windmeijer, “A Finite Sample Correction of the Variance of Linear Efficient Two-step GMM Estimators,” Journal of Econometrics, Vol. 53, 2005, pp. S121-S169.

[29]   J. De Haan, R. Inklaar and R. Jong-a-Pin, “Will Business Cycles in the Euro Area Converge? A Critical Survey of Empirical Research,” Journal of Economic Studies, Vol. 22, No. 2, 2008, pp. 234-273.

[30]   T. Clark and E. van Wincoop, “Borders and Business Cycles,” Journal of International Economics, Vol. 55, No. 1, 2001, pp. 59-85.

[31]   J. Frankel and A. Rose, “The Endogeneity of the Optimal Currency Area Criteria,” Economic Journal, Vol. 108, No. 449, 1998, pp. 1009-1025. doi:10.1111/1468-0297.00327

 
 
Top