Fiscal policy coordination in a monetary union at the zero lower bound

Abstract

[eng] Following the 2008 Financial Crisis, Euro Area governments faced adverse economic environments: high ratios of public debt to GDP, depressed outputs and the prospect of monetary policy hitting the zero lower bound (ZLB). This article assesses to what extent the conduct of fiscal policy differs within a monetary union at the ZLB. Using a fiscal DSGE model with two regions (North and South) calibrated to replicate the conditions where, absent any additional shock, the Euro Area economy would have been stuck at the ZLB for three years starting in 2013, we show that cross-border spillovers from fiscal policy are substantially higher without monetary offset and increase with the extent of fiscal consolidation measures. Spillovers can amount up to half (resp. one sixth) of the domestic impact in the case of VAT-based (resp. spending-based) consolidations. Outside the ZLB, fiscal expansion in one region triggers monetary tightening which has negative effect in the whole union, and gives rise to gains from fiscal cooperation. At the ZLB however, national objectives tend to be closer and the coordinated policy is less consolidating. Moreover, cooperation encourages symmetric rather than asymmetric policies.