Should fiscal policies be centralized in a monetary union? A dynamic game approach

Abstract

In this paper we analyze dynamic interactions in a monetary union with three fiscal players (the governments of the countries concerned) and a common central bank in the presence of exogenous shocks. The model is calibrated for the euro area and includes a fiscally more solid core block denoted as country 1 as well as a fiscally less solid periphery block represented by countries 2 and 3. Introducing two periphery countries allows us to capture different attitudes of the periphery countries towards the goal of sustainable fiscal performance. Moreover, different coalition scenarios are modelled in this study including a fiscal union, a coalition of periphery countries and a coalition of fiscal-stability oriented countries. The exogenous shocks are calibrated in such a way as to describe the last major crises in the euro area, namely the financial crisis, the European sovereign debt crisis, the Covid-19 crisis, and the Ukraine war (energy price) crisis. Using the OPTGAME algorithm we calculate a cooperative Pareto and non-cooperative feedback Nash equilibrium solutions for the modelled scenarios. The fully cooperative solution yields the best results. The different non-cooperative scenarios allow insights into the underlying trade-off between economic growth, price stability and fiscal stability.

Macroeconomic Policy Strategies In A Monetary Union: Simulations With A Dynamic-Game Model

“…9. The results can be summarized as follows; see also (Blueschke et al 2023) for a similar exercise: The policy instruments are used in a countercyclical way during the demand shocks (Figures 1-4), which is expected given the Keynesian structure of MUMOD2 (Figures 5 and 6).…”

Sensitivity analysis for a dynamic macroeconomic policy game in a monetary union

“…As the numerical solutions obtained by Blueschke et al. ( 2023b ) were based on roughly calibrated parameters of the macroeconomic model and the objective functions, the generalizability of our results may be questioned. To counter such objections, in the present paper we conduct a sensitivity analysis for all of the parameters of the model, examining the results under the assumptions of a lower and an upper bound for each parameter.…”

“…The results of the different scenarios can be summarized as follows; for details, see Blueschke et al. ( 2023b ): The policy instruments are used in a countercyclical way during the demand shocks, but monetary policy and mostly also fiscal policy return faster to their long-run course than was actually the case during the crises. On the contrary, neither monetary nor fiscal policy react to the supply-side shock.…”

“…In an earlier paper in this journal (Blueschke et al. 2023b ; see also the earlier work Neck and Behrens 2009 ), we analyzed dynamic interactions in a monetary union with three fiscal players (the governments of the countries or blocks of countries concerned) and a common central bank in the presence of exogenous shocks. The model was calibrated for the Euro Area; it includes a fiscally more solid core block and a fiscally less solid periphery block consisting of two countries (blocks of countries) with different attitudes towards the goal of sustainable fiscal performance.…”