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

Codogno, Lorenzo and van den Noord, Paul (2021) Going fiscal? A stylised model with fiscal capacity and a safe asset in the Eurozone. Review of Economics and Finance, 19. 54 - 72. ISSN 1923-7529

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Identification Number: 10.55365/1923.X2021.19.07

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.

Item Type: Article
Official URL: https://refpress.org/
Additional Information: © 2021 The Authors
Divisions: European Institute
Subjects: H Social Sciences > HG Finance
J Political Science > JN Political institutions (Europe)
H Social Sciences > HB Economic Theory
JEL classification: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions
Date Deposited: 25 Mar 2022 12:42
Last Modified: 31 Mar 2022 12:21
URI: http://eprints.lse.ac.uk/id/eprint/114477

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