Pushing the Limit? Fiscal Policy in the European Monetary Union

Betty Daniel () and Christos Shiamptanis

No 33, Working Papers from Toronto Metropolitan University, Department of Economics

Abstract: Governments are facing increasing scrutiny over debt and deficits following the worldwide recession and financial crisis which began in 2007. Additionally, policy makers are confronted with the growing realization that they face fiscal limits on the size of debt and deficits relative to GDP. These fiscal limits invalidate Bohn's criterion for fiscal sustainability since it allows explosive debt relative to GDP, eventually violating any fiscal limit. The purpose of this paper is to derive restrictions on a fiscal rule, necessary for the government to eliminate explosive behavior. We show that the restrictions require that the response of the primary surplus to debt be relatively strong. Additionally, since fiscal limits rule out explosive behavior, they imply cointegration between debt and the primary surplus, and between the primary surplus and output. We test these two empirical implications for a panel of eleven EMU countries, and find that fiscal policy is responsible, in the sense that governments rule out explosive behavior.

Keywords: European Monetary Union; monetary policy; fiscal policy; fiscal limits; panel cointegration; error correction (search for similar items in EconPapers)
JEL-codes: C32 C33 E42 E62 F33 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2012-06
New Economics Papers: this item is included in nep-eec
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Pushing the limit? Fiscal policy in the European Monetary Union (2013)
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