Abstract
Our paper aims to analyze the effectiveness of different risk-sharing mechanisms in providing stability to a monetary union. We select two stylized tools with extreme and opposite features. The first is an expansionary but conventional monetary policy that is used to help EMU’s most fragile member states manage their public debts; the second is a centralized fiscal policy that allows for the transfer of a portion of these public debts from EMU’s most fragile member states to those considered EMU’s “core”. By a stylized periphery-core model of a monetary union, we compare the strengths and weaknesses of these two tools in order to reach some welfare implications in terms of union stability.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Other risk sharing initiatives are due to the new EMU’s aid programs and financial regulation. It suffices to recall the launch of the European Stability Mechanism (ESM) in December 2010 and the consequent Treaty in March 2012, as well as the Banking Union process opened by the Euro-summit of June 2012 and currently centered on the single supervisory mechanism and the single resolution mechanism.
It is worth noting that a discussion on the optimal rate of inflation is beyond the scope of our paper. Hence, our simplification does not imply any loss of generality. On the other hand, it allows us to label π as the actual average inflation rate in the monetary union.
The breakdown probability is analyzed in some details in Section 2.3.
All variables are expressed in logs.
The apex N indicates that we are referring to the Nash equilibrium case.
The allocation of the control to the core country eases the analytical tractability of our model. We could reach richer results by assuming that the fund is under the control of both countries or, better saying, is centralized at the union level so that the monetary union evolves towards a ‘complete’ fiscal and economic union. It is quite obvious that the last scenario fits with the possible construction of a European Ministry of Finance in the euro-area. However, the discussion of this governance evolution is beyond the scope of this paper (see Bastasin et al. 2017).
The apex K indicates that we are referring to the equilibrium in the indirect risk sharing case, also labelled as the Keynesian case.
The intuitive explanation of the core fiscal authority’s failure in affecting the equilibrium inflation rate is due to the fact that, in our model, the latter just depends on the money supply which is under the full control of the central bank. As a consequence, the core fiscal authority is also unable to influence the peripheral country’s output gap.
The apex S indicates that we are referring to the equilibrium in the direct risk sharing case.
This result highlights the content of fn. 7. If we had assumed that the management of the common fund is under the control of a single centralized fiscal authority, it would have been necessary to analyze the hierarchy and the coordination mechanisms between this centralized authority and the two national fiscal authorities. Our simplification also explains why we did not label this policy regime as a neo-institutional regime.
The same obviously holds if c < c c , that is if the core fiscal authority attributes a larger relative weight to the stability target (see below).
The analytical solution is available upon request.
References
Acocella N, Di Bartolomeo G, Tirelli P (2007a) Fiscal leadership and coordination in the EMU. Open Econ Rev 18:281–289
Acocella N, Di Bartolomeo G, Tirelli P (2007b) Monetary conservatism and fiscal coordination in a monetary union. Econ Lett 94:56–63
Alesina A, Barro RJ (2002) Currency unions. Q J Econ 117:409–436
Alesina A, Tabellini G (1987) Rules and discretion with non-coordinated monetary and fiscal policies. Econ Inq 25:619–630
Bastasin C, Bini Smaghi L, Messori M, Micossi S, Passacantando F, Saccomanni F, Toniolo G (2017) Economic growth and European bargains: why Italy should decrease its government debt. SEP Policy Brief (July 27)
Beetsma R, Bovenberg A (1998) Monetary union without fiscal coordination may discipline policymakers. J Int Econ 45:239–258
Beetsma R, Giuliodori M (2010) The macroeconomic costs and benefits of the EMU and other monetary unions: an overview of recent research. J Econ Lit 48:603–641
Beetsma R, Mavromatis K (2014) An analysis of eurobonds. J Int Money Financ 45:91–111
Blanchard O, Galì J (2007) Real wage rigidities and the new Keynesian model. J Money, Credit, Bank 39:35–66
CESifo (2011) What will Eurobonds cost? Position of the ifo institute CESifo, Munich, 17 August. https://www.cesifo-group.de/ifoHome/presse/Pressemitteilungen/Pressemitteilungen-Archiv/2011/Q3/press_16419057.html
Corsetti G, Hassler J, Saint-Paul G, Sinn H-W, Sturm J-E, Vives X, Devereux MP (2011) A crisis mechanism for the euro. wwwvoxeuorg 11 March
de Kock G, Grilli V (1993) Fiscal policies and the choice of exchange rate regime. Econ J 103:347–358
Depla J, von Weizsäcker J (2010) The blue bond proposal. Bruegel Policy Brief, May
Dixit A, Lambertini L (2001) Monetary–fiscal policy interactions and commitment versus discretion in monetary union. Eur Econ Rev 45:977–987
Favero C, Missale A (2012) Sovereign spreads in the Eurozone: which prospects for a Eurobond? Econ Policy 27:231–273
Furceri D, Zdzienicka A (2015) The euro area crisis: need for a supranational fiscal risk sharing mechanism? Open Econ Rev 26:683–710
Galí J, Monacelli T (2008) Optimal monetary and fiscal policy in a currency union. J Int Econ 76:116–132
Issing O (2009) Why a common eurobond isn't such a good idea. White paper 3, Center for Financial Studies, University of Frankfurt, Frankfurt. https://ifk-cfs.de/fileadmin/downloads/publications/white_paper/White_Paper_No_3_2009_Final.pdf
Messori M (2011) Can the Eurozone countries still live together happily ever after? CEPS Policy Brief, No 239, March
Modigliani F (1944) Liquidity preference and the theory of interest and money. Econometrica 12:45–88
Williamson OE (1985) The economic institutions of capitalism. The Free Press, New York
Acknowledgements
We thank Willi Semmler and Patrizio Tirelli for comments on a more advanced draft.
Author information
Authors and Affiliations
Corresponding author
Additional information
An earlier draft of this paper was discussed at the Fifteenth Annual Conference of EEFS in Amsterdam (June 16–19, 2016). The paper was also discussed at the conference “The Present and future of the EU and EMU: Debts, deficits, and related institutional designs” at the Sapienza University of Rome (December 2–3, 2016).
Rights and permissions
About this article
Cite this article
Canofari, P., Di Bartolomeo, G. & Messori, M. EMU Stability: Direct and Indirect Risk Sharing. Open Econ Rev 28, 847–862 (2017). https://doi.org/10.1007/s11079-017-9462-z
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11079-017-9462-z