Fiscal risk in a monetary union

Betty Daniel () and Christos Shiamptanis

European Economic Review, 2012, vol. 56, issue 6, 1289-1309

Abstract: We present a dynamic and quantitative model of a fiscal solvency crisis in a monetary union. Diverse fiscal policies, which are subject to fiscal limits and stochastic shocks, can threaten a monetary union. The fiscal limits arise due to distortionary taxation and political will. Stochastic shocks are random and could push a fiscally sound policy towards its limit. In equilibrium agents refuse to lend along a path which violates the fiscal limits, creating a fiscal solvency crisis. The dynamics leading to the crisis depend on the policy response to restore lending. We focus on two responses, default and policy switching. We simulate our model to quantify the probability of a fiscal solvency crisis in the European Monetary Union with fiscal variables at end of 2009 values. Our model predicts the Greek crisis which occurred and warns of an Italian one.

Keywords: European monetary union; Fiscal theory of the price level; Policy switching; Default; Financial crisis (search for similar items in EconPapers)
JEL-codes: C63 E62 E63 F34 H63 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (24)

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Working Paper: Fiscal Risk in a Monetary Union (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:56:y:2012:i:6:p:1289-1309

DOI: 10.1016/j.euroecorev.2012.04.004

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