Browsing by Person "Evers, Michael"

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Macroeconomic aspects of fiscal federalism in monetary unions
(2025) Kraft, Julius; Evers, Michael
There is an ongoing policy debate about federal fiscal structures in the European monetary union, that has recently gained new momentum in context of the Recovery and Resilience Facility within the Next Generation European Union programme as well as the reform of the Stability and Growth Pact within the European fiscal framework. This long-standing debate, that originates from the European unification process, has thus far led to a monetary union without a complementary fiscal union. The recent reforms once again raise the question of the desirable degree of federal integration and the optimal design of fiscal institutions in the European monetary union. This thesis assesses the macroeconomic characteristics of different federal fiscal arrangements, common debt structures and risk-sharing mechanisms in a monetary union and derives policy implications for the ongoing debate about fiscal federalism in the European monetary union. The integration of strategically interacting regional fiscal authorities into a structural two-country model of a monetary union allows to quantitatively assess their strategic incentives and the resulting business cycle and welfare effects. Introducing different federal fiscal arrangements and common debt structures to the monetary union yields insights about the resulting incentive effects as well as their macroeconomic consequences. In particular, the analysis focusses on the macroeconomic characteristics of a fiscal equalisation mechanism, a central fiscal authority, a debt rule and common debt in a monetary union. From an empirical perspective, an agnostic orthogonalisation approach is suggested, that allows to decompose the business cycle shocks in the Euro area into their common and idiosyncratic shock components. Analysing their empirical characteristics yields insights about the scope for macroeconomic risk-sharing across the countries of the Euro area. The first chapter identifies the strategic incentives for the regional fiscal authorities in a monetary union to adjust their labour income tax responses and quantifies the resulting business cycle and welfare implications. There is a general trade-off between the adverse incentives for strategic behaviour and the allocative efficiency, so that strategic interac tion results in inefficient allocations and causes welfare losses. Building upon the fiscally decentralised benchmark economy with standard economic frictions, a fiscal equalisation mechanism and a central fiscal authority are introduced to the monetary union. Whereas the regional fiscal authorities have strategic incentives for stronger labour income tax responsiveness to changes in the tax base and the debt-to-GDP ratio than efficient in the benchmark economy, their responses are weaker than efficient with a central fiscal authority. In the presence of strategic interaction, introducing a central fiscal authority improves welfare, whereas a fiscal equalisation mechanism causes welfare losses relative to the benchmark scenario. The second chapter analyses the impact of different common debt regimes and potential adverse strategic incentives within a monetary union. The common debt structures encompass a debt-unrestricted benchmark, a debt rule set-up, and a common debt scenario. Labour income taxation, as the strategic fiscal policy instrument, responds to labour income as the tax base and the regional debt-to-GDP ratio through a feedback rule. The benchmark scenario reveals existing adverse effects from the strategic use of labour income taxation for the regional benefit. This scenario serves as a point of comparison for the optimal labour taxation in the other two common debt regimes. A Nash equilibrium is used to evaluate this strategic component of taxation. The strategic tax component leads to inefficiently high tax rates that require internalisation through different debt structures. In the absence of model frictions such as nominal rigidities and distortionary taxes, the debt rule scenario internalises the inefficiency of the debt effect. In contrast, the common debt case internalises the strategic tax base effect. Taking all frictions into account, both debt scenarios lead to lower and more efficient tax rates, which demonstrates the internalisation of the strategic component. The debt rule and the common debt structure lead to welfare gains compared to the benchmark scenario, both with and without strategic incentives. In addition, these arrangements can mitigate the trade-off between strategic incentives and the allocative efficiency. Especially in the common debt case, the strategic incentives are almost internalised through the additional risk-sharing mechanism. The third chapter decomposes the business cycle shocks in the Euro area into their common and idiosyncratic shock components to evaluate the scope for macroeconomic risk-sharing across countries. The approach is based on the Aoki (1981) transformation, that allows for an agnostic orthogonalisation of the shock components that is independent from structural assumptions. An application to the core and the periphery of the Euro area shows that the cyclical fluctuations are heterogeneous between these groups of countries. Since common shocks explain most of the region-specific shock variance, their shocks are nevertheless highly correlated. Extending the analysis to the initial Euro area countries, the results show that the common shock component explains most of the country-specific shock characteristics and that the idiosyncratic component is relatively less relevant. A risk-sharing mechanism for idiosyncratic shocks has the potential to reduce fluctuations in all Euro area countries, whereas an equalisation of the weighted cyclical differences can even be counter-productive and increase the business cycle fluctuations in some countries. The strategic interaction between the regional fiscal authorities in a monetary union has substantial incentive effects with considerable business cycle and welfare implications. There is a general fiscal policy trade-off between the adverse incentives for strategic behaviour and the allocative efficiency, so that strategic interaction results in inefficient allocations and causes welfare losses. It is demonstrated in how far different publicly discussed federal arrangements and common debt structures internalise the strategic externalities resulting from fiscal policy spillovers. In general, federal integration in a monetary union increases the strategic externalities, so that the adverse incentives are overall weaker. In principle, there is potential for welfare improvements through the coordination of strategic fiscal policies. Given that adverse incentives already exist within the current European fiscal framework, any attempt to internalise the strategic externalities through the federal structure has the potential to generate welfare improvements. However, the estimated scope for macroeconomic risk-sharing across the Euro area countries is limited since common shocks are predominant. Nevertheless, a risk-sharing mechanism for idiosyncratic shocks has the potential to reduce the cyclical fluctuations in all Euro area countries, thereby contributing to the convergence towards a common business cycle.
On the blurring boundaries between monetary and fiscal policy
(2025) Krautter, Victoria; Evers, Michael
In recent decades, several different crises have occurred in the European monetary union at ever shorter intervals. In a monetary union, the centralised monetary policy makes it difficult for member states to react to crises, as only national fiscal policy can be used to combat such crises. This is particularly problematic in the case of asymmetric shocks between member states, because in a monetary union, centralised monetary policy can only react efficiently to symmetric shocks. However, the national asymmetric effects of shocks must be balanced out by national fiscal policy. This makes the role of fiscal policy all the more crucial in the monetary union. Therefore, the interaction between monetary and fiscal policy in a monetary union is essential and must be further explored. As part of my dissertation, I am examining the interaction between monetary and fiscal policy in a monetary union and looking at the effects of different fiscal instruments. I use a dynamic stochastic general equilibrium model with a large fiscal sector for two regions to investigate the introduction of different fiscal instruments in a monetary union. National fiscal policy can cause negative adverse effects between member countries. A national strategically used tax policy of one country can have negative effects on another country, since a country will always try to maximise its own welfare exclusively. This is reflected in the "beggar-thy-neighbour" effect. In the first two projects of my thesis, the question is whether the strategic exploiting of a labour tax rate can be reduced by transfer regimes or public debt arrangements. To this end, a case of pure centralised monetary policy with a strategically used labour tax is compared with the respective introduced fiscal regimes. The additional fiscal transfer regimes include a tax revenue sharing mechanism between the countries and a central fiscal authority that covers indirect transfers between the member countries. A linear debt restriction and a central authority with a common union-wide debt represent the fiscal public debt mechanisms. In order to be able to identify the strategic component of the labour tax rate across all considered regimes, the differences between the Nash equilibrium and the social planner solution are determined. The strategic interaction requires welfare losses and determines an inefficient allocation of resources in the monetary union. Fiscal instruments can partially internalise these strategic incentives and achieve a more efficient allocation. These two projects were co-authored with Prof. Dr. Michael Evers and Julius Kraft. In my third project, I consider a currency union with a central monetary policy in combination with a government debt and a primary deficit limitation rule based on the model of the Maastricht Treaty. This situation is expanded and compared using different transfer regimes such as the tax revenue sharing mechanism and a central fiscal authority with indirect transfers. In addition, the functionality of the primary deficit and government debt rule is analysed with regard to different shocks in the form of an asymmetric productivity and an asymmetric government spending. These additional fiscal rules aim to prevent negative spillover between the two regions due to over-indebtedness and excessive primary deficits. For this purpose, the two restrictions on the primary deficit and the national government debt are described by an exponential function in order to be able to model a one-sided punishment for non-compliance with the respective target values. This guarantees that larger exceedances of the target values are punished more severely than small deviations. In addition, undershoots of the target value are only punished very slightly. This can guarantee greater discipline in compliance with the fiscal rules. The fiscal arrangements can reduce the strategic usage of the labour tax rate compared to a scenario with purely centralised monetary policy. This applies in particular to a central fiscal authority, which can decline the labour tax rate overall. Fiscal arrangements can help diminish strategic incentives and thereby create more efficient allocation. However, this effect is weaker if the model frictions such as distorting taxes, nominal rigidities and mark-ups are neglected. Nevertheless, the fiscal regimes lead to a reduction in the strategic component in the labour tax rate, whereby either the tax base effect or the national debt effect can be reduced. The primary deficit restriction in conjunction with the transfer regimes has a significantly limited effectiveness under the presence of an asymmetric government spending shock although transfers decrease the level of the primary deficit. In contrast, the government debt limitation is actually effective under all regimes and assumed shocks. The punishment of excessive government debt can prevent over-indebtedness. Its functionality is reinforced by the sovereign spread on government debt working as a market discipline mechanism. This is especially true for a central fiscal authority. The interregional risk-sharing in a monetary union enables the member states to protect each other against asymmetric shocks. The transfer regimes with an additional debt and primary deficit restriction diminish income risk-sharing significantly. However, pure transfer or debt regimes without an additional fiscal limitation lead to a substantial increase in the risk-sharing of consumption and income. This strengthens the international insurability of the monetary union as a whole. Although this characteristic is predominantly pronounced for a central fiscal authority with common union-wide debt and indirect transfers. The combination of a primary deficit and government debt restriction rule with the two transfer regimes results in an improvement in welfare compared to a pure centralised monetary policy with a debt and deficit limitation. The strategic exploiting of the labour tax rate reduces the welfare level for all scenarios. The exclusion of this strategic component, on the other hand, always increases the welfare level significantly. This applies regardless of whether a pure centralised monetary policy or a fiscal scenario like transfers or debt restriction is considered. The central fiscal authority has the greatest welfare gains of all considered arrangements. In conclusion, a government debt limitation rule with all regarded transfer scenarios and centralised monetary policy are effective for the observed shocks. The central fiscal authority is particularly characterised by the reduction of the strategic incentives in the labour tax rate, a significant improvement in the interregional risk-sharing and obviously welfare gains. Thus, the highest level of fiscal integration leads to the best results based on the assumed criteria. Both monetary policy and fiscal policy should be centralised in order to achieve the best possible solution for the monetary union as whole.