Abstract
The paper aims at connecting fiscal and external imbalances in the Eurozone. After the shock of the 2007 financial crisis, the current account position was the root cause of discriminatory behavior of foreign lenders towards single countries. Once the interaction between the current account and fiscal imbalances started, the only way out to restore stability and stem capital outflows was to implement fiscal retrenchments and real devaluation. The choice governments of peripheral countries face is therefore, at least in the short run and in recessive conditions, either to restore the equilibrium to their public finance, or to counteract the real shocks coming from the crisis. This suggests to consider that the stability of the Eurozone could be realized at expenses of a lower output in peripheral countries.
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Notes
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).
A great deal has been written on this subject. Here it is worth citing the seminal contribution of Krugman and Rotemberg (1991) for first generation models, Obtstfeld (1986a and 1986b), Kydland and Prescott (1977) for second generation models and Eichengreen and Hausmann (1999)for third generation models. For a review of the content see also Canale et al. (2008).
The European Financial Stability Mehanisms (EFSM) that could lent up to 60 billion Euros with the guarantee of the EU budget and the European financial Stability Facility (EFSF)that could lend up to 440 billion Euros with the guarantee of European Union Member States. Both EFSM and EFSF were not permanent and not based on a written rule of strict conditionality.
In May 2011, the European Council decided that Member States had to present a multi-year repayment plan with the goal of bringing the deficit below 3 % and ensuring the long-term sustainability of public accounts. The text states as follows: “In particular, Member States will present a multi-annual consolidation plan including specific deficit, revenue and expenditure targets, the strategy envisaged to reach the targets and a timeline for its implementation. Fiscal policy for 2012 should aim to restore confidence by bringing debt trends back on a sustainable path and ensuring that deficits are brought back below 3 % of GDP in the timeframe agreed upon the Council. This requires in most cases an annual structural adjustment well above 0.5 % of GDP. Consolidation should be frontloaded in Member States facing very large structural deficits or very high or rapidly increasing levels of public debt” (EU summit 2011). The full text of the EU Summit is available at http://register.consilium.europa.eu/pdf/en/11/st00/st00010.en11.pdf.
Second and third generation models cited in previous pages.
A dynamic version of a risky-return Laffer curve is provided by Bi(2012). The author individuates an endogenous fiscal limit measuring the government’s ability and willingness to service its debt.
Bi (2012) provides microfoundations on how interest rates increase as a function of public debt.
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Canale, R.R., Marani, U. Current account and fiscal imbalances in the Eurozone: Siamese twins in an asymmetrical currency union. Int Econ Econ Policy 12, 189–203 (2015). https://doi.org/10.1007/s10368-014-0268-9
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DOI: https://doi.org/10.1007/s10368-014-0268-9