Macroeconomic Imbalance Procedure in the EU: a Welfare Evaluation

Andrzej Torój

No 22, MF Working Papers from Ministry of Finance in Poland

Abstract: We develop a framework for assessing the welfare implications of the new European Union's (EU) Macroeconomic Imbalance Procedure (MIP) implemented in 2012, with a special focus on the current account (CA) constraint, real effective exchange rate (REER) constraint and nominal unit labour cost (ULC) constraint. For this purpose, we apply a New Keynesian 2-region, 2-sector DSGE model, using the second order Taylor approximation of the households' utility around the steady state as a measure of welfare. The compliance with the CA criterion is ensured by modifying the policymakers' loss function in line with Woodford's (2003) treatment of the zero lower bound of nominal interest rates. The introduction of MIP threshold on CA balance results in a welfare loss equivalent to steady-state decrease in consumption of 0.0274% after the euro adoption or 0.0152% before that. If we consider the 4% threshold on current plus capital account (rather than current account alone), this cost decreases to equivalent to 0.0117% steady-state consumption under the euro and approximately a half of that without the euro. The welfare cost for the converging economies is higher due to persistent, but equilibrium-consistent CA deficits, as well as REER appreciation. MIP can also be seen as a factor augmenting the cost of euro adoption. This working paper is an updated version of the working paper Excessive Imbalance Procedure in the EU: a Welfare Evaluation.

Keywords: Macroeconomic Imbalance Procedure; EMU; DSGE; welfare; constrained optimum policy (search for similar items in EconPapers)
JEL-codes: C54 D60 E42 F32 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2015-10-01
New Economics Papers: this item is included in nep-dge, nep-eec, nep-mac, nep-opm and nep-pbe
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Persistent link: https://EconPapers.repec.org/RePEc:ris:mfplwp:0022

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