HOW MUCH FISCAL DISCIPLINE IN A MONETARY UNION
Paul De Grauwe
London School of Economics
Yuemei Ji
University of Leuven
ABSTRACT
The nature of fiscal policies was changed dramatically by the creation of the Eurozone. While prior to the start of the Eurozone, national governments were sovereign in that they could back up the issue of debt by the issue of money, they lost this sovereignty in the Eurozone. This had dramatic effects that were largely overlooked by the designers of the Eurozone. First it made self-fulfilling liquidity crises possible that degenerated into solvency crises. Second, it led to the imposition of intense austerity program. We provide empirical evidence for these two effects. We argue that contrary to what was expected, i.e. that a monetary union loosens fiscal discipline, it actually leads to too much fiscal discipline.
Keywords: fiscal policy, austerity, Eurozone, EMS
JEL Classification: E42, E58, F33, F36
Acknowledgements: We are grateful to the participants of the conference for many useful comments and suggestions and in particular to our discussant, George Hondroyiannis. The views expressed in this paper are those of the authors and do not necessarily reflect those of the London School of Economics and the University of Leuven.
Correspondence:
Paul De Grauwe
European Institute
London School of Economics and Political Science
Houghton Street,
London WC2A 2AE, UK
Tel: +44 (0)20 7955 6464
Email: p.c.de-grauwe@lse.ac.uk