In this paper I put the Euro area and all its member countries centerstage and analyze the combination of their different fiscal policies and the one monetary policy. Especially the monetary transmission in the single member countries and the fiscal spillovers between those countries are examined. Furthermore I capture the interdependency between the two and present it first in a stylized two country simulation exercise and later in a fully blown up model. Major results are that monetary transmission differs across countries quantitatively but not qualitatively. Fiscal spillovers matter and are sizeable for some big countries. More over monetary policy conduct on the aggregate euro area level yields different outcomes than on the aggregated country level.
In the past many different strings have evolved in the literature concerning these policies. Fiscal analysis has until recently very often been empirical and dealt with the multiplier determination in a closed economy, starting with Blanchard, Perotti (2002). Work on fiscal spillover analysis in open economies has equally been unstructured most of the time (Beetsma, Klassen, Cimadomo (2007)). Only recently have fiscal topics found entrance in structural models, eg. DSGE models. (Cwik and Wieland (2009), Corsetti et al. (2009)). In another branch the monetary transmission of ECB policy on the member countries has been heatedly discussed at the very beginning of the establishment of the Eurozone with data on the pre-monetary union situation (for example in Ehrmann (2000) and McAdam and Morgan (2001)).
Those studies were mostly empirical and neglected a fiscal side that could interfere with monetary transmission at least theoretically. But it seems that research action in this field has heavily cooled down since then with the exception of Weber et al. (2008). Then there is a different branch of literature that looks at both policies at the same time. One important started with Leeper (1991) who has looked at so called active and passive policies of both authorities and identified areas of (in-)determinacy. This field of the fiscal theory of the price level has become a very debated one with Chung et al. (2007) and Buiter (2002) as active discussants.
With respect to monetary and fiscal policy in a monetary union in the beginning of the creation of the Euro Area many papers have been written on fiscal policies of certain countries free riding at the disadvantage of others and how one common monetary policy could react to this (an example hereof would be Gali and Perotti (2003)) None of these different strings has so far to my knowledge been considered together. So analysis in a large macroeconomic and macroeconometric framework is to my knowledge extremely rare so far with the important exception of Gali and Monacelli (2008). In the present study I perform a model basedempirical analysis on these two policies jointly where fiscal spillovers and monetary policy transmission in the member countries of the euro area are analyzed. The open New Keynesian model that is set up for each of the eleven original member countries consists of households, firms, a retailer and a fiscal authority. Monetary policy is determined at the union wide level.
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Fiscal Spillovers and Monetary Policy Transmission in the Euro Area
