Managing external macroeconomic imbalances in the EU: the welfare cost of scoreboard-based constraints

Andrzej Torój

Economic Modelling, 2017, vol. 61, issue C, 293-311

Abstract: This paper investigates the consequences of introducing a new economic governance tool in the European Union - Macroeconomic Imbalance Procedure. We focus on the external imbalances and especially on the lower limit of −4% imposed on the current account deficit to GDP ratio. Using a 2-region, 2-sector New Keynesian DSGE model and Woodford's technique to operationalise inequality constraints, we demonstrate that it is possible to accordingly adjust monetary and fiscal policy. The utility-based welfare loss remains very limited as compared to optimum unconstrained policy, as measured for Poland on the basis of Bayesian estimation, and this result is robust over a wide range of parameter values. The cost is slightly lower i.a. when (i) the monetary policy is autonomous (outside the euro area), (ii) for non-converging economies, (iii) when the limit is relaxed by incorporating positive capital account to GDP ratio. The procedure also envisages lower limits on REER and ULC dynamics, but the latter can be in conflict with the CA constraint, especially in the monetary union. Therefore, the scoreboard-based evaluation of external imbalances - while not very costly - has definitely some room for fine-tuning in the course of future MIP reforms.

Keywords: Macroeconomic Imbalance Procedure; DSGE; Welfare; Constrained optimum policy; European Union (search for similar items in EconPapers)
JEL-codes: C54 D60 E42 F32 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:61:y:2017:i:c:p:293-311

DOI: 10.1016/j.econmod.2016.10.009

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