Fiscal Policy, Monetary Regimes and Current Account Dynamics


  • The authors would like to thank in particular Giovanni Melina, Lukas Vogel, and an anonymous referee as well as participants of the International Atlantic Economic Conference (Istanbul, 2012), the 13th Conference on International Economics (Granada, 2012), the annual meeting of the “Verein für Socialpolitik” 2012 (Göttingen), and the International Conference on “Intra-European Imbalances, Global Imbalances, International Banking, and International Financial Stability” (Berlin, 2012) for very helpful comments.


For the individual European Monetary Union (EMU) members fiscal policy has gained in importance owing to the loss of monetary policy as an autonomous policy instrument. Based on a small open economy dynamic stochastic general equilibrium (DSGE) model with fiscal feedback rules, we analyze the dynamic macroeconomic response in particular of the current account under alternative exchange rate regimes. Our results indicate that entry into monetary union makes the economy more vulnerable to a productivity shock and leads to higher variability of the current account. For a risk premium shock, an entry into EMU implies lower variability of most macroeconomic variables, but a higher persistence in the adjustment process of the current account. For both shocks, a countercyclical fiscal response to the current account is more stabilizing for most macroeconomic variables than a conventional countercyclical response to output. Stabilizing the current account comes at the price of higher variability of output in the short-run, however.