Discussions on the fiscal framework should aim to correct its procyclical nature with a view to promoting more cooperative outcomes.
The rationale behind the Maastricht fiscal
criteria was to prevent excessive spending (driven by uncoordinated
fiscal policies) in response to external shocks. Excessive spending
would in turn put market pressure on those ‘undisciplined’ fiscal
authorities and compromise the long-term stability of the monetary
In reality, fiscal policy was too loose
during economic booms, when it ought to have aimed to build up buffers
and too restrictive in recessions, when it ought to have cushioned
shocks. Fiscal policy in the euro area on average has therefore been procyclical.
Additionally, monetary policy, through the
European Central Bank (ECB), has had to do a lot more than envisaged in
order to compensate for the fiscal inaction during recessions. Now at
the zero-lower bound, the ECB has less room for manoeuvre by
conventional means and has built up an unprecedented balance sheet
position. We still need to understand what this means for the real
economy, monetary policy effectiveness and the independence of the
We argue that the procyclical nature of
fiscal policy in the euro area and the subsequent overuse of monetary
policy are not just outcomes. Rather, they are a failure of the fiscal
framework to recognise (even unintentionally) that there are strategic
interactions that, if not appropriately accounted for, lead to such
A setup that aimed to prevent negative
spillovers produced a strategic environment where, in the face of a
negative shock, all countries ended up being more restrictive than they
ought to. This prolonged the recessionary period caused by the negative
shock and forced monetary policy from its first best.
By contrast, explicit cooperation between
fiscal authorities can help improve outcomes for all. Fiscal authorities
will be playing a bigger role to address the shocks, without ignoring
the negative externalities in place. Also, monetary policy will not be
as active so that macroeconomics management achieves better outcomes.
The non-cooperative versus cooperative outcomes comparison serves as a
good way of contrasting the overall macro response in the financial
crisis to that in the pandemic crisis in the EU.
The Maastricht criteria were never a good tool for fiscal coordination
We describe this strategic interaction in the context of European monetary union based on the Hamada diagram (see here).
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