Abstract
The paper aims at estimating the existence of a trilemma in the Eurozone, i.e., to assess to what extent the net capital flows, the volatility of bond yields and the fiscal stance are strictly linked to each other constraining countries’ ability to manage the internal policy goals. The existence of constraints on policy alternatives is estimated for 11 Eurozone countries from 2002 till 2012. The sample is then divided into pre- (2002–2008) and post-crisis (2009–2012) periods. A further division between the PIIGS and the non-PIIGS is then applied. The results show the validity of the trilemma for the whole Euro area and for the whole period but with some distinction between the pre- and post-crisis periods and between the PIIGS and the non-PIIGS countries. The existence of the trilemma underlines the presence of national constraints and suggests, for the future of the Eurozone, to push towards centralized fiscal policy instruments.
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Notes
About the history of the theoretical foundations of the so-called Mundell-Fleming model and about its separate origins see Mundell (2001).
This contrasts with the “Keynesian view” according to which fiscal restrictions further increase the deficit/GDP and debt/GDP ratios because of the positive value of the fiscal multiplier. These two contrasting views have re-appeared in recent publications: on the one hand that stability needs to be restored through severe fiscal retrenchment (Neumann 2012). On the other hand, that public investment programs need to be implemented to compensate for the output gap (De Long and Summers 2012). The debate on the effectiveness of austerity measures is synthetically reported in Corsetti (2012).
They are available on the Eurostat website.
Despite the countries considered in the empirical analysis are 11, the average values with which to calculate the correlation are those of the 12 Eurozone countries because they represent the reference values of the Eurozone as a whole.
After the year 2012 a new phase began, characterized by a lower financial instability, a greater fiscal discipline and greater capital mobility. To evaluate this change in the trade-offs among these policy alternatives a big number of observations would be required. Since they are not available, the paper stops the empirical investigation at the year of the supposed switch.
This division in groups reduces the risks of a spurious regression. In addition a cointegration analysis as in Aizenman et al. (2013) cannot be implemented to reduce the risks of a spurious regression since the methodology used does not allow for testing a long-run relationship of dependence among variables. As a matter of fact the indicators, to make the trilemma binding, need to vary in opposite direction in a compensative way.
This is allowed by the significance of empirical estimates obtained with the introduction of a dummy variable assuming the value of 0 when considering Germany, France, the Netherlands, Austria, Finland and Belgium and the value of 1 in the other cases. The results of the estimates with the dummy are not reported in the paper for the sake of discussion flow.
It is worth to be noted the case of Greece for which separate regressions gives the following results:
2002-2012
2002-2008
2009-2012
FS
BY
KAO
FS
BY
KAO
FS
BY
KAO
obs
44
28
16
Greece
0.947***
3.247
1.260***
1.260***
1.181
2.327***
2.387***
3.309***
0.055***
For the whole period as well as for 2002–2008, the trilemma is not binding. It becomes binding in the period 2009–2012. This suggest a misevaluation of financial markets about Greece’s risk
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Canale, R.R. Capital flows, long term bond yields and fiscal stance: the Eurozone policy trilemma. Port Econ J 14, 31–44 (2015). https://doi.org/10.1007/s10258-015-0110-5
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DOI: https://doi.org/10.1007/s10258-015-0110-5