EU306 lecture slides7 - CLASS ANNOUNCEMENTS No class on...

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CLASS ANNOUNCEMENTS No class on April 23 Midterm Make-up Exam on April 28 at 13.30 in room M501
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Fiscal Policy and the Stability and Growth Pact Monetary union – loss of monetary policy BUT fiscal policy still remains National fiscal policies affect other countries A country has 2 macroeconomic instruments: 1. Monetary policy – lost in a monetary union 2. Fiscal policy – retained even in a monetary union
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Fiscal Policy and the Stability and Growth Pact (cont.) In the Euro area fiscal policy therefore becomes very important! In case of asymmetric shocks fiscal policy is the only available macroeconomic instrument But fiscal policy is more difficult to activate and less reliable than monetary policy
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Fiscal Policy and the Stability and Growth Pact (cont.) Fiscal policy – changes in spending and/or taxes Fiscal policy is also very slow to implement Ex. In monetary policy – central bank can change interest rates very quickly;
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Fiscal Policy and the Stability and Growth Pact (cont.) In fiscal policy – establishing the budget is a very long process - Government must agree on budget - Ministers will negotiate - Parliament must approve budget - Spending must be enacted by bureaucracy - Taxes take time to increase Sometimes during this process the situation fiscal policy is trying to solve dissapears
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Fiscal Policy and the Stability and Growth Pact (cont.) Another way of looking at fiscal policy: government borrows and pays back on behalf of its citizens During a slowdown – government budget deficit financed by public borrowing During an upswing – government budget surplus – government pays back its debt
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Fiscal Policy and the Stability and Growth Pact (cont.) Individual firms and citizens could lead to the same effect, in principle, by borrowing in bad years and paying back in good years The government simply acts as a bank vis-a-vis its citizens This makes sense because when the economy slows down lending becomes generally riskier and banks become cautious
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Fiscal Policy and the Stability and Growth Pact (cont.) Many citizens and firms cannot borrow in bad times When governments are considered a good risk (as is the case in Europe) they can borrow at a relatively low cost
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Fiscal Policy and the Stability and Growth Pact (cont.) Europe also fares poorly in inter-country transfer (remember OCA theory!) This is the equivalent of a transfer When a country faces a negative asymmetric shock its government can borrow from countries that are not affected by the shock
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Fiscal Policy and the Stability and Growth Pact (cont.) Instead of receiving a loan or grant from other EMU governments the affected country can borrow on international private markets This way fiscal policy makes up for the absence of a “federal” transfer in a monetary union
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Fiscal Policy and the Stability and Growth Pact (cont.) Basically – if government borrows to reduce taxes now it will raise taxes later to pay back its debt
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EU306 lecture slides7 - CLASS ANNOUNCEMENTS No class on...

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