Going fiscal? A stylised model with fiscal capacity and a safe asset in the Eurozone

Lorenzo Codogno and Paul Van den Noord

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper examines the impact of rebalancing the policy mix away from monetary towards fiscal stimu-lus 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 ag-gregate 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 unconvention-al monetary policy.

Keywords: business fluctuations; European Monetary Union; fiscal policy; monetary policy (search for similar items in EconPapers)
JEL-codes: E32 E63 F33 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2021-03-28
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (3)

Published in Review of Economics and Finance, 28, March, 2021, 19, pp. 54 - 72. ISSN: 1923-7529

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