Giovanni Callegari, Francesco Drudi, Keith Kuester; The fiscal mix in the euro-area crisis: dimensions and a model-based assessment of effects. Econ Policy 2017; 32 (89): 127-169. doi: 10.1093/epolic/eiw020
The current paper contributes to the debate about fiscal policy’s role in shaping euro-area macroeconomic developments by providing facts: it documents the evolution of the euro-area’s fiscal mix since 2007 both across countries and across a broad set of fiscal instruments. The paper, then, evaluates the effects of the fiscal mix against one particular counterfactual. Namely, the paper asks: how would the euro-area macroeconomy have evolved if the Member States had strictly adhered to the fiscal behaviour embedded in pre-crisis fiscal rules? Towards this end, the paper first puts the fiscal mix into the context of New Keynesian business cycle theory, arguably the dominant theory of business cycles to date. The paper, then, builds a two-country model of a currency union to provide a quantitative assessment of how the fiscal mix may have affected the ‘Core’ countries and the ‘Periphery’ of the euro-area. The results suggest that fiscal policy in the euro-area as a whole and in each of the two blocks separately stimulated economic activity more and that public debt rose more than would have been the case under strict adherence to pre-crisis fiscal behaviour.