Project FIRSTRUN (G.A. 649261) funded by Horizon 2020 January 29 th - PowerPoint PPT Presentation

Project FIRSTRUN (G.A. 649261) funded by Horizon 2020 January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 1 / 16

Fiscal Policy Coordination and Deleveraging Financed through the project FIRSTRUN (Grant Agreement 649261), funded by the Horizon 2020 Framework Programme of the European Union. Alexandre Lucas Cole, Chiara Guerello and Guido Traficante LUISS Guido Carli (Rome) FIRSTRUN Final Conference January 29 th 2018 CEPS (Brussels) January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 2 / 16

Motivation Global economic crisis − → future of European economic integration = ⇒ need for fiscal policy coordination in Euro Area? One monetary policy in EMU − → address Euro-wide shocks = ⇒ country-specific fiscal policies − → address country-specific shocks? Sovereign debt crisis in Euro Area = ⇒ best way and timing for deleveraging? January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 3 / 16

Strategy A two-Country DSGE model of a Currency Union = ⇒ analyze stabilization properties of scenarios for coordination Calibrated to mimic: Germany (Country H) The Rest of the Euro Area (Country F) Two setups: Balanced-budget fiscal policies in both countries + complete international financial markets = ⇒ analyze gains from fiscal policy coordination Government debt deleveraging in the Rest of the Euro Area + Germany balances the budget + incomplete international financial markets = ⇒ evaluate different deleveraging schemes and instruments January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 4 / 16

Setup for Coordination Three degrees of fiscal policy coordination: Pure Currency Union : Independent fiscal policy − → no coordination = ⇒ government consumption reduces output gap Coordinated Currency Union : Countries coordinate = ⇒ government consumption reduces net exports gap Full Fiscal Union : Government consumption reduces net exports gap + government budget constraint is consolidated + financed by symmetric movements in tax rates across countries = ⇒ sharing costs of government spending January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 5 / 16

Coordination - Results Governments keep real debt constant + fiscal policy is financed by movements in taxes + international financial markets are complete: Reducing output gap − → more distortions reducing net exports gap = ⇒ more stabilization Reducing net exports gap + consolidating budget constraints + symmetric movements of tax rates across countries = ⇒ even more stabilization Taxes on labour income to finance fiscal policy − → more distortions taxes on firm sales = ⇒ more stabilization January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 6 / 16

Coordination - Key Mechanisms Negative technology shock in country H = ⇒ increase in prices + decrease in output Prices in country H are more flexible − → terms of trade fall = ⇒ fall in net exports + recession for country H + boom for country F Pure Currency Union : opposite movements across countries of output, government consumption and taxes = ⇒ big movements in terms of trade Coordinated Currency Union : opposite movements across countries of output and government consumption + taxes move in the same direction = ⇒ less movements in terms of trade Full Fiscal Union : symmetric movement in tax rates = ⇒ terms of trade are even more stable Fiscal policy financing : tax rate on labour income − → affects mainly output through labour supply tax rate on firm sales − → affects mainly prices through price setting January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 7 / 16

Coordination - Simulation Mix of Tax on Wage and on Sales ( . = 0.5) - Technology Shock in Country H Total Taxes (H) Gov. Cons. (H) GDP (H) Consumption (H) 0.5 0.1 0.2 0 0 0 -0.02 -0.1 0 -0.2 -0.2 -0.04 -0.4 -0.3 -0.5 -0.4 -0.6 -0.06 0 10 20 0 10 20 0 10 20 0 10 20 Total Taxes (F) Gov. Cons. (F) GDP (F) Consumption (F) 0.2 0.1 0.4 0.02 0.3 0 0 0.05 0.2 -0.02 0.1 -0.2 0 -0.04 0 -0.4 -0.05 -0.1 -0.06 0 10 20 0 10 20 0 10 20 0 10 20 Net Exports (H) Terms of Trade (H) Interest Rate 10 0.05 0.03 0 0 Pure Currency Union 0.02 -0.05 Coordinated Currency Union -10 Full Fiscal Union -0.1 0.01 -20 -0.15 -30 -0.2 0 0 10 20 0 10 20 0 10 20 January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 8 / 16

Coordination - Simulation Pure Currency Union - Technology Shock in Country H 4 # 10 -4 Gov. Cons.(H) 6 # 10 -3 3 # 10 -3 Sales Taxes (H) 2 # 10 -3 Labour Taxes (H) GDP (H) 4 2 3 0 2 1 2 -2 0 0 1 -4 -2 -1 -4 -2 0 -6 0 10 20 0 10 20 0 10 20 0 10 20 0 # 10 -4 Gov. Cons. (F) 0 # 10 -3 Labour Taxes (F) 0 # 10 -4 Sales Taxes (F) 6 # 10 -3 GDP (F) -0.5 -2 4 -2 -1 -4 2 -1.5 -4 -6 0 -2 -6 -8 -2.5 -2 0 10 20 0 10 20 0 10 20 0 10 20 4 # 10 -4 Interest Rate 1 # 10 -3 Net Exports (H) Terms of Trade (H) 0.1 0 0 3 . = 0.8 . = 0.5 -0.1 . = 0.2 -1 2 Non-distortionary Tax -0.2 -2 1 -0.3 -0.4 -3 0 0 10 20 0 10 20 0 10 20 January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 9 / 16

Setup for Deleveraging Three degrees of fiscal policy coordination with deleveraging : Pure Currency Union : Government consumption reduces output gap + taxes or transfers reduce government debt in Rest of the Euro Area + taxes balances the budget in Germany Coordinated Currency Union : Government consumption reduces net exports gap + taxes or transfers reduce government debt in Rest of the Euro Area + taxes balance the budget in Germany Full Fiscal Union : Government consumption reduces net exports gap + taxes or transfers reduce government debt in Rest of the Euro Area + taxes balance the budget in Germany + government budget constraint is consolidated + financed by symmetric movements in tax rates across countries = ⇒ sharing the costs of government spending and deleveraging January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 10 / 16

Deleveraging - Results Germany keeps real debt constant + Rest of the Euro Area deleverages government debt + debt-elastic government bond spread (higher interest rate for higher debt): Reducing net exports gap = ⇒ more stabilization creating some form of fiscal union = ⇒ often more stabilization Using distortionary taxes to deleverage = ⇒ more stabilization = ⇒ counteracts deflationary effect of deleveraging shock January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 11 / 16

Deleveraging - Key Mechanisms Negative debt target shock in country F from 80% to 60% → debt is reduced by 5% of the excess over 60% each year − Deleveraging with transfers : In country F transfers decrease − → private consumption decreases → prices fall + labour supply increases − = ⇒ output increases = ⇒ taxes fall In country H interest rate falls − → private consumption increases → labour supply decreases − = ⇒ output falls = ⇒ taxes increase Prices in country H are more flexible − → terms of trade fall = ⇒ fall in net exports + recession for country H + boom for country F Deleveraging with taxes : opposite movements across countries of output and private consumption + taxes move in the same direction = ⇒ less movements in terms of trade and net exports January 29 th 2018 - CEPS Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 12 / 16

Instruments for Deleveraging - Simulation Deleveraging in Pure Currency Union - Deleveraging Shock in Country F Total Taxes (H) Gov. Tr. (H) Gov. Cons. (H) GDP (H) 6 1 1 0 4 -5 0.5 0.5 2 -10 0 0 0 -15 0 20 40 0 20 40 0 20 40 0 20 40 Total Taxes (F) Gov. Tr. (F) Gov. Cons. (F) GDP (F) 5 10 10 15 0 10 0 0 -10 5 -5 -10 -20 0 -10 -30 -20 -5 0 20 40 0 20 40 0 20 40 0 20 40 Net Exports (H) Terms of Trade (H) Consumption (H) Consumption (F) 0 0 1 1 -2 0 -2 -4 0.5 -1 -4 -6 -2 -6 -8 0 -3 0 20 40 0 20 40 0 20 40 0 20 40 Interest Rate Gov. Bond Spread (F) Gov. Debt (F) 0.1 0 0 0 -0.2 -10 Taxes -0.1 -0.4 Government Transfers Government Consumption -20 -0.2 -0.6 -0.3 -0.8 -30 0 20 40 0 20 40 0 20 40 January 29 th 2018 - CEPS All variables are in % deviation from s.s. Taxes, Interest Rate, Inflation Rates and Gov. Bond Spread are in p.p. deviation from s.s. Cole, Guerello, Traficante (LUISS) Fiscal Policy Coordination and Deleveraging 13 / 16