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Open Economies Review

, Volume 24, Issue 1, pp 165–196 | Cite as

The Performance of Simple Fiscal Policy Rules in Monetary Union

  • Lukas Vogel
  • Werner Roeger
  • Bernhard Herz
Research Article

Abstract

The paper analyses the stabilising potential of simple fiscal policy rules for a small open economy in monetary union in a 2-region DSGE model with nominal and real rigidities. We consider simple fiscal instrument rules for government purchases, transfers, and consumption, labour and capital taxes in analogy to interest rate rules in monetary policy. The paper finds a dichotomy in the welfare effects of fiscal policy for liquidity-constrained and intertemporal optimising households, i.e. policies enhancing the welfare of one group tend to reduce the welfare of the other one. The moderate average welfare gains from optimal policy contrast with potentially large welfare losses from non-optimal policy. Fiscal rules that respond to employment fluctuations may be preferred to fiscal rules responding to indicators of price competitiveness, because optimal policy corresponds more closely to the idea of countercyclical stabilisation in the former case. The simulations also emphasise the crucial impact of the budgetary closure rule on the welfare consequences of fiscal business-cycle stabilisation.

Keywords

Fiscal policy Monetary union Simple instrument rules Welfare 

JEL classification

E37 E62 F41 

Notes

Acknowledgments

We thank the anonymous referee, Davide Furceri, Robert King, Apostolos Serletis, the guest editors Georgios Kouretas and Athanasios Papadopoulos, the editor George Tavlas, and participants of the 16th Annual Conference on Macroeconomic Analysis and International Finance for helpful comments and suggestions.

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Copyright information

© European Union 2012

Authors and Affiliations

  1. 1.DG Economic and Financial Affairs, European CommissionBrusselsBelgium
  2. 2.DG Economic and Financial Affairs, European CommissionBrusselsBelgium
  3. 3.VWL 1, Department of Law and EconomicsUniversity of BayreuthBayreuthGermany

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