Theory, Evidence and Institutions
4. 1. Cyclical stabilization* INTRODUCTION The policy assignment and institutional arrangements of EMU are based on a widespread consensus that monetary policy should take care of stabilization in the event of symmetric shocks while the smoothing of asymmetric shocks and diverging cyclical conditions falls to national ﬁscal policy as the single monetary policy responds only to area-wide price developments. The feasibility of this policy assignment rests of course on the assumption that ﬁscal policy is an eﬀective stabilization tool. Recent academic literature assessing the functioning of the rule-based ﬁscal framework of EMU draws largely on the presumption that ﬁscal policy is indeed a useful stabilization instrument.62 This implies a turnaround in the views concerning the potency of ﬁscal policy interventions in smoothing cyclical ﬂuctuations. Since the collapse of the Keynesian consensus in the second half of the 1970s, ﬁscal stabilization has become increasingly unpopular among academics and policy makers. While the real eﬀects of ﬁscal policy were called into question in Barro’s (1974) seminal paper on Ricardian equivalence, Sargent and Wallace (1981) revealed ‘ﬁscal roots’ of high inﬂation in the form of debt monetization in the event of persistent budgetary imbalances.63 Reﬂecting these underpinnings, the task of short-term stabilization was left to monetary policy, whereas ﬁscal policy should be geared to medium-term structural issues and long-term sustainability of public ﬁnances. While the potential usefulness of ﬁscal stabilization is being reconsidered, the ‘heritage’ of the debate in the 1980s casts a strong scepticism over the use of...
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