Advertisement

Adhere to the rules or be discretionary? Empirical evidence from the euro area

  • Zongsen ZouEmail author
  • Xiuling Wang
  • Dengtian Feng
Regular Article
  • 10 Downloads

Abstract

This paper constructs a framework for modelling the interaction between monetary and fiscal policies before and after the formation of the euro area with a view to determining how and why member states’ fiscal policies become more discretionary after the adoption of the euro. Two hypotheses are theoretically derived and empirically tested, developing results with predictions in a robust manner based on various checks. The paper concludes that prior to joining the euro area, the fiscal policies of the member states only respond to demand shocks. However, after joining the euro area, states follow a more discretionary approach that suits both demand and supply shocks, whether domestically or abroad and regardless of the strict rules of the Stability and Growth Pact and other treaties, particularly in response to adverse shocks. This change in fiscal policies in response to economic shocks originates from the asymmetric policy structure: a common monetary policy outlined by the European Central Bank in the euro area, which contrasts with the fiscal policies determined individually by national governments. Although the European Union has been consolidating its governance structure since the recent global financial crisis and the ensuing European sovereign-debt crisis, substantial efforts continue to be required to transform the euro area into a thorough and genuine economic and monetary union.

Keywords

Euro area Discretionary fiscal policy Economic shock Spillover effect 

Notes

Acknowledgements

We thank the two referees for their very helpful and constructive comments.

Funding

This work was funded by the National Social Science Fund of China (Grant Number 16BJL087).

References

  1. Afonso A, Sousa RM (2012) The macroeconomic effects of fiscal policy. Appl Econ 44(34):4439–4454Google Scholar
  2. Agell J, Calmfors L, Jonsson G (1996) Fiscal policy when monetary policy is tied to the mast. Eur Econ Rev 40(7):1413–1440Google Scholar
  3. Agnello L, Furceri D, Sousa RM (2013) How best to measure discretionary fiscal policy? Assessing its impact on private spending. Econ Model 34:15–24Google Scholar
  4. Beetsma R, Giuliodori M (2011) The effects of government purchases shocks: review and estimates for the EU. Econ J 121(550):F4–F32Google Scholar
  5. Beetsma RMWJ, Jensen H (2005) Monetary and fiscal policy interactions in a micro-founded model of a monetary union. J Int Econ 67(2):320–352Google Scholar
  6. Bellemare MF, Masaki T, Pepinsky TB (2017) Lagged explanatory variables and the estimation of causal effect. J Polit 79(3):949–963Google Scholar
  7. Benigno P (2004) Optimal monetary policy in a currency area. J Int Econ 63(2):293–320Google Scholar
  8. Blanchard OJ, Quah D (1989) The dynamic effects of aggregate demand and supply disturbances. Am Econ Rev 79(4):655–673Google Scholar
  9. Bofinger P, Mayer E (2007) Monetary and fiscal policy interaction in the euro area with different assumptions on the Phillips curve. Open Econ Rev 18(3):291–305Google Scholar
  10. Cabral R, Díaz RG (2015) Is fiscal policy coordination desirable for a monetary union? An assessment from the perspective of a small open economy. Invest Econ-Mex 74(294):3–72Google Scholar
  11. Calvo GA (1983) Staggered prices in a utility-maximizing framework. J Monet Econ 12(3):383–398Google Scholar
  12. Canofari P, Di Bartolomeo G, Messori M (2017) EMU stability: direct and indirect risk sharing. Open Econ Rev 28(5):847–862Google Scholar
  13. Choi I (2001) Unit root tests for panel data. J Int Money Financ 20(2):249–272Google Scholar
  14. Christiano LJ, Eichenbaum M, Evans CL (2005) Nominal rigidities and the dynamic effects of a shock to monetary policy. J Polit Econ 113(1):1–45Google Scholar
  15. Clarida R, Gali J, Gertler M (2000) Monetary policy rules and macroeconomic stability: evidence and some theory. Q J Econ 115(1):147–180Google Scholar
  16. Cover JP, Enders W, Hueng CJ (2006) Using the aggregate demand-aggregate supply model to identify structural demand-side and supply-side shocks: results using a bivariate VAR. J Money Credit Bank 38(3):777–790Google Scholar
  17. De Grauwe P (2012) The governance of a fragile Eurozone. Aust Econ Rev 45(3):255–268Google Scholar
  18. De Grauwe P, Ji Y (2013) Self-fulfilling crises in the Eurozone: an empirical test. J Int Money Financ 34:15–36Google Scholar
  19. De Grauwe P, Ji Y (2014) How much fiscal discipline in a monetary union? J Macroecon 39:348–360Google Scholar
  20. De Grauwe P, Ji Y (2017) Governing a sustainable Eurozone. Riv Int Sci Sociali 125(2):173–194Google Scholar
  21. De Haan J, Berger H, Jansen D (2004) Why has the stability and growth pact failed? Int Financ 7(2):235–260Google Scholar
  22. Dixit A, Lambertini L (2001) Monetary-fiscal policy interactions and commitment versus discretion in a monetary union. Eur Econ Rev 45(4–6):977–987Google Scholar
  23. Dixit A, Lambertini L (2003) Symbiosis of monetary and fiscal policies in a monetary union. J Int Econ 60(2):235–247Google Scholar
  24. Eichengreen B (2008) Globalizing capital: a history of the International Monetary System. Princeton University Press, New JerseyGoogle Scholar
  25. Eichengreen B, Ghironi F (2002) Transatlantic trade-offs in the age of balanced budgets and European monetary union. Open Econ Rev 13(4):381–411Google Scholar
  26. Engwerda JC, Van Aarle B, Plasmans JEJ (2002) Cooperative and non-cooperative fiscal stabilization policies in the EMU. J Econ Dyn Control 26(3):451–481Google Scholar
  27. Engwerda J, Van Aarle B, Plasmans J, Weeren A (2013) Debt stabilization games in the presence of risk premia. J Econ Dyn Control 37(12):2525–2546Google Scholar
  28. Ernst E, Semmler W, Haider A (2017) Debt-deflation, financial market stress and regime change—evidence from Europe using MRVAR. J Econ Dyn Control 81:115–139Google Scholar
  29. European Commission (2017) Reflection paper on the deepening of the economic and monetary union. Technical Report, European CommissionGoogle Scholar
  30. Evers MP (2015) Fiscal federalism and monetary unions: a quantitative assessment. J Int Econ 97(1):59–75Google Scholar
  31. Ferré M (2008) Fiscal policy coordination in the EMU. J Policy Model 30(2):221–235Google Scholar
  32. Galí J, Monacelli T (2008) Optimal monetary and fiscal policy in a currency union. J Int Econ 76(1):116–132Google Scholar
  33. Ghironi F, Giavazzi F (1998) Currency areas, international monetary regimes, and the employment-inflation tradeoff. J Int Econ 45(2):259–296Google Scholar
  34. Greene WH (2012) Econometric analysis, 7th edn. Prentice Hall, New JerseyGoogle Scholar
  35. Gros D, Mayer T (2010) Towards a European Monetary Fund. Policy brief, CEPSGoogle Scholar
  36. Im KS, Pesaran MH, Shin Y (2003) Testing for unit roots in heterogeneous panels. J Econom 115(1):53–74Google Scholar
  37. Jarociński M, Maćkowiak B (2018) Monetary-fiscal interactions and the euro area’s malaise. J Int Econ 112:251–266Google Scholar
  38. Jawadi F, Mallick SK, Sousa RM (2016) Fiscal and monetary policies in the BRICS: a panel VAR approach. Econ Model 58:535–542Google Scholar
  39. Jones J (2012) Discretionary fiscal policy and the European monetary union. Modern Ec 3:742–751Google Scholar
  40. Juncker J-C, Tusk D, Dijsselbloem J, Draghi M, Schulz M (2015). Completing Europe’s economic and monetary union: the five presidents’ report. Technical Report, European CouncilGoogle Scholar
  41. Lof M, Malinen T (2014) Does sovereign debt weaken economic growth?A panel VAR analysis. Econ Lett 122(3):403–407Google Scholar
  42. Love I, Zicchino L (2006) Financial development and dynamic investment behavior: evidence from panel VAR. Q Rev Econ Finance 46(2):190–210Google Scholar
  43. Magazzino C (2016) Economic growth, CO2 emissions and energy use in the South Caucasus and Turkey: a PVAR analyses. Int Energy J 16(4):153–162Google Scholar
  44. Mankiw NG, Reis R (2002) Sticky information versus sticky prices: a proposal to replace the new Keynesian Phillips curve. Q J Econ 117(4):1295–1328Google Scholar
  45. Pedroni P (2013) Structural panel VARs. Econometrics 1(2):180–206Google Scholar
  46. Pizzati L (2000) Monetary policy coordination and the level of national debt. Empirica 27(4):389–409Google Scholar
  47. Ravn MO, Schmitt-Grohé S, Uribe M (2012) Consumption, government spending, and the real exchange rate. J Monet Econ 59(3):215–234Google Scholar
  48. Reed WR (2015) On the practice of lagging variables to avoid simultaneity. Oxford B Econ Stat 77(6):897–905Google Scholar
  49. Roberts JM (1995) New Keynesian economics and the Phillips curve. J Money Credit Bank 27(4):975–984Google Scholar
  50. Romer CD, Romer DH (2004) A new measure of monetary shocks: derivation and implications. Am Econ Rev 94(4):1055–1084Google Scholar
  51. Rudd J, Whelan K (2005) New tests of the new-Keynesian Phillips curve. J Monet Econ 52(6):1167–1181Google Scholar
  52. Semmler W, Haider A (2018) Cooperative monetary and fiscal policies in the euro area. South Econ J 85(1):217–234Google Scholar
  53. Semmler W, Young B (2017). Re-booting Europe: what kind of fiscal union–what kind of social union? Working Paper 13/2017, The New School for Social ResearchGoogle Scholar
  54. Sun J (2011) The sovereign debt crisis and asymmetries within the euro area. Chin J Eur S 1:30–56Google Scholar
  55. Tabellini G (1986) Money, debt and deficits in a dynamic game. J Econ Dyn Control 10(4):427–442Google Scholar
  56. Uhlig H (2002) One money, but many fiscal policies in Europe: what are the consequences? CEPR Discussion Papers No. 3296Google Scholar
  57. Van Aarle B, Garretsen H, Huart F (2004) Monetary and fiscal policy rules in the EMU. Ger Econ Rev 5(4):407–434Google Scholar
  58. Van Rompuy H, Barroso J M, Juncker J-C, Draghi M (2012) Towards a genuine economic and monetary union. Technical report, European CouncilGoogle Scholar
  59. Von Hagen J, Mundschenk S (2003) Fiscal and monetary policy coordination in EMU. Int J Finance Econ 8(4):279–295Google Scholar
  60. Zou Z, Yuan L (2014) An empirical analysis on asymmetric shocks to the euro area based on SVAR methods. Stud Int Finance 10:32–42Google Scholar

Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.School of BusinessQingdao University of TechnologyQingdaoThe People’s Republic of China

Personalised recommendations