Servaas Deroose

Reviewing Adjustment Dynamics in EMU: From Overheating to Overcooling

This paper analyses how adjustment dynamics, in an environment with some degree of price and wage rigidity, may create and strengthen asymmetric developments in a monetary union. It presents a simple illustrative model of adjustment dynamics that reproduces quite nicely actual developments in the first years of EMU. The model is used to analyse adjustments to two types of shocksrelative competitiveness shifts and demand disturbances. It is shown that the interaction between real exchange rate adjustment and real interest rate developments may contribute to periods of overheating and overcooling during which output might be for a number of years either above or below potential.Furthermore, the paper looks at the circumstances in which smooth adjustment to shocks can be expected and, on the other hand, when a cycle with greater amplitude is more likely. Finally, the paper examines policy options that could improve the functioning of EMU. The analysis provides another strong argument for pressing ahead with reforms that increase flexibility in labour and product markets and further integrate the economies of the euro area.

Constricted, lame and pro-cyclical? Fiscal policy in the euro area revisited

It is often argued that fiscal stabilisation in the euro area compares unfavourably with the USA, not least because of the perceived limitations of the stability and growth pact. This paper qualifies this perception. It examines a number of elements which are generally overlooked or not considered in the analysis of fiscal stabilisation. On top of discretionary fiscal policy, which is generally at the core of existing studies, it also takes into account the size of automatic stabilisers. Moreover, it considers the difference between policy intentions, as formulated or perceived in real time, and actual outturns, and possible reasons for the gap between the two. On the basis of such an analysis, fiscal stabilisation in the euro area appears less dire than commonly assumed. This paper also advances a number of points on how to improve the track record of fiscal policy making in the euro area, in particular on how to make is less pro-cyclical and, in the end, more sustainable.

Introduction: The Role of Fiscal Rules and Institutions in Shaping Budgetary Outcomes

Economic literature has provided a wide range of analyses on how taxes, government spending and budget balances should be set over the cycle in order to ensure sound and sustainable fiscal policies. However, recent economic history has shown that fiscal policy often departs from what could be considered optimal. The large increases of debt ratios over recent decades and the tendency to conduct pro-cyclical fiscal policies, notably in good times, are well-known examples of such sub-optimal behaviour. The causes for the deficit and pro-cyclical biases have been extensively researched in the literature. The explanations generally point to political economy considerations, notably to the fact that policy-makers may not always have the right incentives to conduct sustainable and time-consistent policies in the long run.