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The COVID-19 shock and a fiscal-monetary policy mix in a monetary union

Anna Bartocci (), Alessandro Notarpietro () and Massimiliano Pisani ()

No 1313, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: This paper evaluates the macroeconomic effects of a monetary and fiscal policy mix implemented in a two-region monetary union in response to the COVID-19 shock. The pandemic is modelled as a mix of recessionary demand and supply shocks affecting both regions simultaneously and symmetrically, under two assumptions: the effective lower bound (ELB) constrains the monetary policy rate; and a fraction of households, labelled ‘hand-to-mouth’ (HTM), consume all their available income in every period. The main results are the following: first, higher lump-sum targeted fiscal transfers to HTM households and public consumption spending in one region, financed by issuing public debt, reduce the recessionary effects both domestically and abroad (via the trade channel). Second, the monetary union-wide recession is mitigated more effectively if both regions implement a fiscal expansion and the central bank limits the increase in long-term rates by purchasing sovereign bonds. Third, fiscal measures are less effective if sovereign bond yields increase relatively more in one region because investors perceive its bonds as risky. Effectiveness can be regained if a supranational fiscal authority issues a safe bond.

Keywords: monetary policy; fiscal policy; effective lower bound (search for similar items in EconPapers)
JEL-codes: E31 E32 E58 (search for similar items in EconPapers)
Date: 2020-12
New Economics Papers: this item is included in nep-dge, nep-eec and nep-mac
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Chapter: Covid-19 Shock and Fiscal-Monetary Policy Mix in a Monetary Union (2022)
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