Prelims
Fiscal and Monetary Policy in the Eurozone: Theoretical Concepts and Empirical Evidence
ISBN: 978-1-78754-126-9, eISBN: 978-1-78743-793-7
Publication date: 13 May 2019
Citation
Canale, R.R. and Mirdala, R. (2019), "Prelims", Fiscal and Monetary Policy in the Eurozone: Theoretical Concepts and Empirical Evidence, Emerald Publishing Limited, Leeds, pp. i-xiii. https://doi.org/10.1108/978-1-78743-793-720191005
Publisher
:Emerald Publishing Limited
Copyright © 2019 Emerald Publishing Limited
Half Title Page
Fiscal and Monetary Policy in the Eurozone
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Praise for Fiscal and Monetary Policy in the Eurozone
“Canale and Mirdala guide us through the world of policy and modeling explanations concerning developments in the Eurozone…. This well-written book provides coverage of a number of important issues and techniques treated in a refined didactic manner.”
– Julius Horvath, Central European University, Hungary
“This book is useful both for readers interested in the euro area and those interested in the theoretical foundations of economic policies. This double perspective is rarely present in a single book.”
– Jean-Pierre Allegret, Full Professor of Economics, Head of GREDEG, CNRS and University Nice Sophia Antipolis, France
“(This book) addresses the needs of the Eurozone for alternative and pragmatic approaches to theoretical inquiry and policy making in a manner not typically found in other publications.”
– Nikolaos Karagiannis, Winston-Salem State University, USA
“This book is an important contribution to the discussion of the most advances regional integration project on the planet.”
– Martina Metzger, Berlin School of Economics and Law, Germany
“This book will be of much interest to students, scholars, and policy makers interested in understanding the fundamental origins of the euro-area crisis.”
– Sergio Rossi, University of Fribourg, Switzerland
“Fiscal and Monetary Policy in the Eurozone by Rorita Canale and Rajmund Mirdala is an in-depth and useful text…. The book represents a valuable contribution to the analysis and the economic policy debate regarding the Eurozone.”
– Daniele Schiliro, University of Messina, Italy
“Fiscal and Monetary Policy in the Eurozone: Theoretical Concepts and Empirical Evidence provides a complete and lucid narrative of the fiscal and monetary policy in the Eurozone.”
– Yaya Sissoko, Indiana University of Pennsylvania, USA
Title Page
Fiscal and Monetary Policy in the Eurozone: Theoretical Concepts and Empirical Evidence
by
Rosaria Rita Canale
Parthenope University of Naples, Italy
and
Rajmund Mirdala
Technical University of Košice, Slovakia
United Kingdom – North America – Japan India – Malaysia – China
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Emerald Publishing Limited
Howard House, Wagon Lane, Bingley BD16 1WA, UK
First edition 2019
Copyright © 2019 Emerald Publishing Limited
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A catalogue record for this book is available from the British Library
ISBN: 978-1-78754-126-9 (Print)
ISBN: 978-1-78743-793-7 (Online)
ISBN: 978-1-78743-981-8 (Epub)
Contents
| List of Figures, Tables | ix | ||
| Preface | xi | ||
| Acknowledgements | xiii | ||
| Introduction | 1 | ||
| Chapter 1 | The Policy Framework in the Eurozone | 5 | |
| 1.1. The European Monetary Union: Historical Roots and Recent Events | 5 | ||
| Box 1.1 The Optimal Currency Area Theory | 9 | ||
| 1.2. Policy Principles from World War II to the Fall of Bretton Woods | 12 | ||
| Box 1.2 Fiscal and Monetary Policy Under Alternative Exchange Rates Regimes and Perfect Capital Mobility: The Mundell–Fleming Model | 17 | ||
| 1.3. From the Exchange Rate Agreements to the Common Currency: The Policy Model of the New Consensus Macroeconomics | 22 | ||
| 1.4. The Present Policy Framework of the Eurozone | 27 | ||
| Chapter 2 | Fiscal Policy in the Eurozone | 31 | |
| 2.1. From Keynesian Macroeconomics to Contemporary Theory | 31 | ||
| 2.2. Fiscal Policy Theory in a Keynesian World | 32 | ||
| Box 2.1 Inflation and Output Effects of Expansionary Fiscal Policies: The Slope of the Supply Curve | 35 | ||
| Box.2.2 Fiscal Policy Rules in the Eurozone | 37 | ||
| 2.3. Fiscal Policy and the Intertemporal Approach | 40 | ||
| 2.4 .The Evolution of the Theoretical Debate and the Case of the Eurozone | 44 | ||
| 2.5. The Empirical Literature | 49 | ||
| 2.6. The Issue of Public Debt and the Need to Implement Structural Public Balance Adjustments | 54 | ||
| Box 2.3 The Crowding-out Effect in a Monetary Union | 59 | ||
| Chapter 3 | Monetary Policy in the Eurozone | 65 | |
| 3.1. Theoretical Basis of the Monetary Policy Conduction | 65 | ||
| 3.1.1. Phillips Curve a NAIRU | 65 | ||
| 3.1.2. The Relationship between Inflation and Economic Growth | 71 | ||
| 3.1.3. Sources of Inflation | 72 | ||
| Box 3.1 Specific Approaches to Inflation | 76 | ||
| 3.1.4. Effects of Reducing Inflation | 79 | ||
| 3.1.5. Selected Approaches to Deflation | 82 | ||
| 3.1.6. Exchange Rate and Inflation Relationship | 84 | ||
| 3.1.7. Consequences of Exchange Rate Fluctuations | 85 | ||
| 3.1.8. Real Exchange Rate | 86 | ||
| 3.2. Conduction of Monetary Policy and its Macroeconomic Aspects | 91 | ||
| 3.2.1. The Importance of the Nominal Anchor in the Conduction of Monetary Policy | 94 | ||
| Box 3.2 Fixed Versus Flexible Exchange Rate Dilemma (Evidence from New EU Member Countries) | 98 | ||
| Box 3.3 Evolution of Exchange Rate Regimes in the European Transition Economies | 101 | ||
| Box 3.4 Monetary Policy and the Exchange Rate System | 112 | ||
| 3.2.2. Transmission Mechanism of Monetary Policy | 114 | ||
| 3.2.3. The Importance of the Operational Criterion in the Transmission Mechanism of Monetary Policy | 117 | ||
| Box 3.5 Impact of Quantitative and Qualitative Approach to the Monetary Policy Conduction on Central Bank’s Balance Sheet | 122 | ||
| 3.2.4. Choice between Inflation and Price Targeting | 125 | ||
| 3.3. Evolution of the ECB’s Monetary Policy | 126 | ||
| 3.3.1. First Phase: Monetary Policy Beginning and Adjustment (1999–2003) | 128 | ||
| 3.3.2. Second Phase: Monetary Policy Until the Financial Crisis (2003–2007) | 131 | ||
| 3.3.3. Third Phase: Global Financial Crisis and Great Recession (2008–2013) | 132 | ||
| 3.3.4. Fourth Phase: Ultra-low Inflation and QE (2014 to the Present) | 134 | ||
| Box 3.6 Overview of the Instruments Employed via a Broad Policy of Liquidity Provision to the Banking Sector Employed by ECB (2018) | 135 | ||
| 3.4. Monetary Policy Controversies | 137 | ||
| 3.4.1. Qualitative and Quantitative Approach to the Monetary Policy Conduction | 137 | ||
| 3.4.2. Rules Versus Discretion | 140 | ||
| 3.4.3. Taylor Rule | 143 | ||
| 3.5. Monetary Policy in DSGE Model | 146 | ||
| Chapter 4 | Policy Coordination in the Eurozone | 153 | |
| 4.1. Policy Coordination in the Eurozone: A General Framework | 153 | ||
| Box 4.1. International Spillover Effects under Floating Exchange Rate Regimes | 155 | ||
| 4.2. Fiscal Policy, Monetary Policy, and Financial Markets: A Stylized Model for A Country Belonging to The Eurozone | 158 | ||
| 4.2.1. National Government Behavior | 159 | ||
| 4.2.2. Financial Market Behavior | 161 | ||
| 4.2.3. A Graphical Representation | 161 | ||
| 4.2.4. Case 1. Sustainable Shocks | 162 | ||
| 4.2.5. Case 2. Unsustainable Shocks | 162 | ||
| 4.3. Policy Coordination and External Equilibrium | 165 | ||
| 4.4. Policy Coordination and the Future of the Eurozone | 170 | ||
| Box 4.2 Unpleasant Effects of Restrictive Fiscal Measures in the Eurozone | 172 | ||
| Conclusions | 177 | ||
| References | 181 | ||
| Index | 195 | ||
List of Figures, Tables
Figures
| Fig. 1.1 | Effects of an Asymmetric Shock in Two Different Countries Belonging to a Monetary Union. | 10 |
| Fig. 1.2 | Automatic Rebalancing through Wage Flexibility or Labor Mobility of an Asymmetric Shock | 11 |
| Fig. 1.3 | Policy Instruments and Objectives Under the Principle of “Effective Market Classification.” | 16 |
| Fig. 1.4 | Monetary Expansion Under a Flexible Exchange Rate Regime. | 18 |
| Fig. 1.5 | Fiscal Expansion Under a Flexible Exchange Rate Regime. | 19 |
| Fig. 1.6 | Changes in Money Supply Under Fixed Exchange Rates. | 20 |
| Fig. 1.7 | Changes in Government Expenditure Under Fixed Exchange Rates. | 21 |
| Fig. 1.8 | A Stylized Illustration of the Transmission Mechanism from Interest Rates to Prices. | 26 |
| Fig. 2.1 | Inflationary Effects of Demand Changes Under Alternative Hypotheses on the Slope of the Supply Curve. | 35 |
| Fig. 2.2 | Debt Dynamics in the Case of g>r. | 55 |
| Fig. 2.3a | Debt Dynamics in the Case of g<r and d>0. | 56 |
| Fig. 2.3b | Debt Dynamics in the Case of g<r and d<0. | 56 |
| Fig. 2.4 | Ten-year Government Bond Yields in 11 EZ Countries (1999–2017). | 57 |
| Fig. 2.5 | Crowding-out Effects in a Monetary Union. | 60 |
| Fig. 2.6 | GDP Growth Rates in 11 EZ Countries (1999–2017). | 62 |
| Fig. 2.7a | Change in Structural Balance and Change in Debt in 11 EZ Countries: 2000–2009. | 63 |
| Fig. 2.7b | Change in Structural Balance and Change in Debt in 11 EZ Countries. | 64 |
| Fig. 3.1 | Phillips Curve, USA (1956–1969). | 66 |
| Fig. 3.2 | Phillips Curve, USA (1956–2007). | 69 |
| Fig. 3.3 | Phillips Curve, USA (1956–1984). | 69 |
| Fig. 3.4 | Phillips Curve, Eurozone (1997–2017). | 70 |
| Fig. 3.5 | Transmission Mechanism of Monetary Policy. | 114 |
| Fig. 3.6 | Quantitative and Qualitative Approach to the Monetary Policy Conduction. | 137 |
| Fig. 3.7 | Structure of the New Keynesian Model | 149 |
| Fig. 4.1 | Monetary Policy Spillover Effects Under Floating Exchange Rates. | 156 |
| Fig. 4.2 | Fiscal Policy Spillover Effects Under Floating Exchange Rates. | 157 |
| Fig. 4.3 | Sound Fiscal Dynamics. | 162 |
| Fig. 4.4 | Unsound Fiscal Dynamics. | 163 |
| Fig. 4.5 | Solution to Unsound Fiscal Dynamics. | 164 |
| Fig. 4.6 | Long-term Interest Rates on Government Bonds and Current Account as a Percentage of GDP inSelected Eurozone Countries 2004–2007. | 167 |
| Fig. 4.7 | Long-term Interest Rates on Government Bonds and Current Account as a Percentage of GDP in Selected Eurozone Countries (2008–2011). | 168 |
| Fig. 4.8 | Eurozone Trilemma Triangle. | 170 |
| Fig. 4.9 | Material Deprivation and Cumulative Structural Adjustment: Yearly Means. | 173 |
| Fig. 4.10 | Change in Material Deprivation and Cumulative Structural Adjustment from 2005-2015 in Single EZ Countries. | 174 |
Tables
| Table 2.1 | Competing Schools of Thought and Fiscal Policy: Hypotheses and Outcomes. | 47 |
| Table 3.1 | Exchange Rate Regimes in New EU Member Countries. | 104 |
| Table 3.2 | Operational and Intermediate Criteria of Monetary Policy. | 120 |
Preface
This book was born from the intention to present in a different light and in a systematic way the institutional structure that regulates economic policy in the European Monetary Union.
The view is shared by both authors, which, despite belonging to different countries and with different personal experiences in respect to the Eurozone institutional consolidation process, found themselves convinced that it was necessary to make explicit the connection between the evolution of the economic theory and the path of construction of the European Monetary Union. The underlying idea is that the rules that determine its functioning are the result of the evolution of economic theory in light of historical facts and that it is essential to understand their meaning in terms of policy proposals. As the Keynesian approach revealed to be inadequate to interpret the facts after the 1970s, now the consolidated new neoclassical synthesis approach appears to be unable to solve the asymmetries inside the Eurozone without questioning the existence of the whole currency area. This approach provides a new perspective from which to examine the current Eurozone policy equilibria and, in the light of current crisis, calls for new answers in terms of policy prescriptions.
The authors would like to thank their families: someone would think that without their presence the book would have been written more quickly. However, they know that in the absence of those affections, they would not have had the necessary strength to carry out the project.
This book is dedicated to Rorita’s family – Francesco, Anna, and Benedetta and Rajmund’s family – Paulina and Ivana.
Acknowledgements
This book benefited from the financial support of the University of Naples “Parthenope”, assigned on an award basis to Rosaria Rita Canale.
This book was written in connection with scientific project VEGA No. 1/0793/19. Financial support from this Slovak Ministry of Education scheme is also gratefully acknowledged.