Cooperative and non-cooperative fiscal stabilization policies in the EMU

Abstract

In this paper we analyze the interaction of fiscal stabilization policies in the Economic and Monetary Union (EMU). The ‘Excessive Deficits’ procedure of the Maastricht treaty and its elaborations in the recent ‘Stability and Growth Pact’ introduce a set of fiscal stringency requirements on national fiscal policies. Situations might arise where the need for fiscal flexibility and the fiscal stringency requirements will create a conflict and suboptimal macroeconomic policies are implemented. We analyze macroeconomic adjustment under non-cooperative and cooperative fiscal policy design in the EMU using a dynamic games approach. In particular, we consider how fiscal stringency requirements like the Stability and Growth Pact affect fiscal policy design under EMU and study the consequences of the introduction of a fiscal transfer mechanism between countries.