Lecture on Sovereign Risk and the Recent Crisis in the Eurozone (part I) Flashcards
In a monetary union, what does fiscal policy mean?
- The only remaining macroeconomic instrument on national level
- Government borrows in slowdown and pays back on behalf of citizens
- Government acts as substitute to inter-country transfers in case of asymmetric shock
What are the problems of fiscal policy?
- Effectiveness of fiscal policy depends on private expectations
- Slow implementations
- Undisciplined fiscal policy results in high public debt which in turn may destabilize economies
What is meant with “automatic stabilizers”?
Fiscal policy is spontaneously countercyclical
What is meant with discretionary fiscal policy?
A voluntary decision to change tax rates or spending
What is the footprint of automatic stabilizers?
Difference between actual and cyclically adjusted budget
When should fiscal policy be subjected to some form of coordination?
When fiscal policies are a significant source of externalities
What are potential spillover (externalities) channels?
- Trade
- Inflation
- Borrowing costs
- Financial Distress
What four spillovers were identified by the founding fathers of the euro?
- Debt monetization would undermine ECB independence
- Heavy public borrowing by one member country is a sign of indiscipline that could trouble the international financial markets.
- A government that accumulates a debt that it can nog longer service must default which causes massive capital outflow, a collapse that would be union-wide in the EMU
- The threat of one member country’s default would so concern all other member goverments that they would feel obliged to bail out the nearly bankrupt government
What is the deficit bias?
Deficits allow governments to deliver goods and services today, but
without facing the costs, in effect passing the burden to future
governments or even to future generations
The theory of fiscal federalism deals with which question?
At which level of government should policies be conducted?
What are two arguments for sharing responsibilites
- Externalities / spillovers
- Increasing returns to scale
What are two arguments for retaining sovereignity?
- Heterogeneity of preferences
- Information asymmetries
Theory of fiscal federalism does not provide a general answer, what is needed?
Case-by-case approach
What is the principle of subsidiarity/
The burden of proof lies with those who argue in favour of sharing sovereign tasks. Unless there is a strong case of increasing returns to scale or externality, the presumption is that decisions remain at the national level.
What is the Stability and Growth Pact?
The SGP was meant to avoid excessive deficits, with fines for countries not respecting it. SGP was reformulated in 2005 to avoid its rigidity.
The SGP consists of which five elements?
- Definition of what constitues an ‘excessive deficit’
- Preventive arm designed to encourage governments to avoid excessive deficits
- Corrrective arm which prescribes how governments should react to a brech of the deficit limit
- Procedures designed to embed members country’s budget process within a European Framework
- Sanctions
When are deficits excessive according to the SGP?
When they are above 3 percent of GDP
What is the weakness of the deficit treshold?
The existence of automatic stabilizers. when an adverse asymmetric shock occurs, the limit can be breached. At the same time, an adverse shock is just when a fiscal policy expansion is desirable.
What does the SGP require regarding the strucutral budget?
It should always be in balance or suplus, meaning that the deficit does not exceed 0.5 per cent of GDP
When is the public debt excessive according to SGP?
When it exceeds 60 per cent of GDP
Why do many governments exhibit a deficit bias?
Domestic pressure and political expediency
What is the Medium-Term Objectgive (MTO)?
The budget balance that countries commit to acheiving within a three-year period. The MTO must be compatible with ‘minimum benchmarks’ established by the European Commission
When is the corrective arm aplpied?
When a country does not meet the requirements of the SGP the 3 per cent deficit and 60 per cent debt limits - it is declared in excessive deficit by the Council
What happens when recommended course of action by the council is repeatedly not followed?
A sanction procedure is triggered
