Abstract:

This paper examines the impact of rebalancing the policy mix away from monetary towards fiscal stimulus in the Euro zone, achieved at the supranational level by introducing a safe asset together with fiscal capacity at the centre. The model used is consensus Mundel-Fleming for a two-country (‘core’ and ‘periphery’) closed economy adapted to the critical features of Europe’s Economic and Monetary Union. Specifically, alongside the determination of output, inflation and trade, the determination of financial flows and yields is explicitly modelled while the internal nominal exchange rate is fixed. Simulations are run in which a safe asset – dubbed Eurobond – replaces national bonds on banks and central bank’s balance sheets, and a fiscal capacity at the center with the power to adjust the aggregate fiscal stance is introduced. Moreover, a new quantitative easing scheme, mandating the European Central Bank to adjust its portfolio of Eurobonds as deemed necessary in the pursuit of price stability, is introduced. The main conclusion emerging from the simulations is that had a Eurobond/fiscal capacity existed at the onset of the Great Financial Crisis, the recession would have been much more muted, and with much less need for unconventional monetary policy

Keywords:

European Monetary Union, business fluctuations, fiscal policy, monetary policy.

JEL Classification:

E32, E63, F33

How to Cite:

Lorenzo Codogno and Paul van den Noord. Going Fiscal? A Stylised Model with Fiscal Capacity and a Safe Asset in the Eurozone. [ref]: vol.19.2021. available at: https://refpress.org/ref-vol19-a7/