SIMPLE RULES, FISCAL POLICY and WEALTH TARGETS IN A MONETARY UNION. AN ALTERNATIVE TO THE MAASTRICHT GUIDELINES
| Published date | 01 November 1994 |
| DOI | http://doi.org/10.1111/j.1467-9485.1994.tb01134.x |
| Author | M. Lossani,P. Tirelli |
| Date | 01 November 1994 |
Scorrish
Journal
of
Polirial
Economy.
Vol.
41.
No.
4.
November
1994
0
Scottish Economic Society
1994.
Published by Blackwell Publishers.
108
Cowley
Road. Oxford
OX4
IJF.
UK
and
238
Main
Slreel.
Cambridge,
MA
02142.
USA
SIMPLE RULES, FISCAL POLICY AND
WEALTH TARGETS IN A MONETARY UNION.
AN ALTERNATIVE TO THE MAASTRICHT
GUIDELINES
M.
Lossani*
and
P.
Tirelli
*
*
I
INTRODUCTION
In this paper we investigate the issue of fiscal policy in a monetary union.
No
doubt, the EMS crisis has thrown in disarray plans to a fast track European
Monetary Union (EMU) and the EMU issue might now seem outdated. How-
ever, given the deeply rooted interest in economic and political integration in
Europe, the currency unification question is likely to come back in the future.
It
has been argued that EMU requires binding rules for national fiscal poli-
cies. The rationale for binding rules is twofold. On the one hand they should
prevent the accumulation of excessive stocks of public debt. On the other hand,
it has been claimed that they are needed to ensure an appropriate fiscal policy
stance for the union as a whole, avoiding a possible bias towards lack of fiscal
restraint, which would eventually undermine monetary stability. The Maas-
tricht Treaty goes along these lines. However, the strict and unfeasible guide-
lines set for national fiscal policies have contributed to ignite the EMS crisis.
Thus the road is open to the search for viable alternatives, which are consis-
tent with financial stability and yet allow
for
some flexibility. In fact, excessive
constraints on fiscal policy may be undesirable from a more general point of
view. First of all, this instrument may be used for stabilization purposes in the
face of asymmetric shocks, acting as a surrogate for the lost flexibility of the
intra-union nominal exchange rate. Secondly, budgetary policies may play a
role in ensuring intergenerational equity and the formation of an adequate level
of capital.
To reconcile these views, we advocate the use of a simple fiscal rule which
links national fiscal policies to wealth targets. Such rule should limit excessive
deficits, avoid competition for savings within the community, and still retain
the flexibility needed for macroeconomic stabilization. We contrast the per-
formance of this proposal against two alternatives. The first implies that fiscal
policy should not respond to current macroeconomic conditions. The second
assumes that centralized fiscal policies control the union current account.
*
Universita’
Cattolica,
Milano
**
Universita’
della
Calabria,
Cosenza
372
FISCAL
POLICY
AND WEALTH IN A MONETARY UNION
373
We do not rank the performance
of
each assignment according
to
a
formal
loss function,
’
instead we stress some apparent strengths and shortcomings
of
each assignment. In doing this, we explicitly take into account the behaviour
of
the intra-union real exchange rate, whose variability may be regarded as an
indicator
of
the economic cost
of
monetary unification.
We look at the results from two different perspectives. On the one hand, we
consider the point
of
view
of a
global controller which aims to stabilize the
union as
a
whole and reduce national differences.
On
the other hand, we look
at national outcomes. We do believe that this distinction is important because
inconsistencies may arise between national and global interests. Thus, to assess
the performance
of
rules we shall consider both the stabilizing effects on the
economy hit by the shock,
and
the effectiveness in limiting negative exter-
nalities on the rest
of
the union.
The paper is divided into seven sections. In Section I1
a
rationale for the
adoption of a wealth target
as
a
policy objective is provided. Section
111
lays
out the model. In Sections IV, V and
VI,
we examine the performance
of
poli-
cies in the face
of
three asymmetric shocks, focusing on long run multipliers
and dynamic adjustments. Section VII presents the conclusions.
11
SIMPLE
FISCAL
RULES
AND
FOREIGN
WEALTH
TARGETS
The debate on the use
of
national fiscal policies in
EMU
has been centred
around ‘the need for
a
system
of
coordination and self-imposed constraints’
(Currie,
1992).
The form that such arrangements should take is still unclear.
The challenge is to find a solution which prevents the growth of national debt
levels to unsustainable positions and yet avoids excessive constraints on
national fiscal policies.
As
Goodhart
(1992)
pointed out, those in favour
of
binding constraints for
national fiscal policies essentially stressed the following points:
0
the average fiscal stance, resulting from national policies, should help to
determine the community external position and the exchange rate.
0
competition for
EMU
savings should be avoided as it might lead to fiscal
laxism.
Nonetheless, fiscal stabilization in response to asymmetric disturbances may
be desirable. Once the nominal intra-union exchange rate is irrevocably fixed,
adjusting the
real
exchange rate requires the modification
of
the whole array
of
a country’s prices, but in
a
world
of
sticky wages this may be difficult.
Indeed, real exchange variability may be regarded as an indicator
of
the
economic cost
of
monetary unification (Vaubel,
1978).
To
mitigate adjustment
costs, several scholars have advocated fiscal intervention as a surrogate for
nominal exchange rate flexibility.
*
Simple state-contingent fiscal rules might avoid undesirable budget deficits
’
As
in
Frenkel
el
at.
(1988).
Masson and Melitz (1990), Wyplosz (1990). (Begg
era/.,
1991), Masson and Taylor (1992).
0
Scottish
Economic
Society
1994
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