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Given that exchange rate devaluations are no longer available in a monetary union, fiscal devaluations are one potential way to address divergence in competitiveness and trade imbalances. Employing a DSGE model calibrated to the euro area, we quantify the international effects of a fiscal devaluation implemented as a revenue-neutral shift from employers’ social contributions to the value added tax. We find that a fiscal devaluation carried out in the South has a strong positive effect on output, which is five times larger than under a wage tax cut. However, the effect on the trade balance and the real exchange rate is mild. The negative effect on the North’s output is weak.

We analyze the conduct of fiscal policy in a financially integrated union in the presence of financial frictions. Frictions create a wedge between the return to investment and the union interest rate. This leads to an over-spending externality. While the social cost of spending is the return to investment, governments care mostly about the (depressed) interest rate they face. In other words, the crowding-out effects of public spending are partly “exported” to the rest of the union. We argue that it may be hard for the union to deal with this externality through the design of fiscal rules, which are bound to be shaped by the preferences of the median country and not by efficiency considerations. We also analyze how this overspending externality—and the union’s ability to deal with it effectively—changes when the union is financially integrated with the rest of the world. Finally, we extend our model by introducing a zero lower bound on interest rates and show that, if financial frictions are severe enough, the union is pushed into a liquidity trap and the direction of the spending externality is reversed. At such times, fiscal rules that are appropriate during normal times might backfire.

Many advanced economies are heading into an era of fiscal stress: populations are aging and governments have made substantially more promises of old-age benefits than they have made provisions to finance. This paper models the era of fiscal stress as stemming from growing promised government transfers that initially are fully honored, being financed by new sales of government debt that bring forth higher future income taxes. As debt levels and tax rates rise, the population's tolerance for taxation declines and the probability of reaching the fiscal limit increases. At the limit a fixed tax rate is adopted, adjustments in taxes no longer stabilize debt, and, temporarily, debt grows rapidly. Eventually, a new stabilizing combination of policies is adopted. We examine how, in the period before the fiscal limit, rapidly rising debt interacts with expectations of how and when policies will adjust. If households believe it is possible that in the future monetary policy will shift from targeting inflation to stabilizing debt, then temporarily explosive debt feeds directly into the path of inflation. News that reduces expected primary surpluses can bring future inflation into the present, well before the news shows up in fiscal measures. This paper makes the point that even if long-run policies give monetary policy perfect control over inflation, in the transition to that long run, monetary policy can spectacularly lose control.

We construct a new, global tariff dataset and apply it to a multi-sector quantitative trade model with heterogeneous firms, including nearly all countries of the world. The impact of the Uruguay Round tariff reductions over 1990–2010 is analyzed, as well as the further cuts in Preferential tariffs and the impact of moving to complete free trade. We find that the Uruguay Round tariff cuts led to large welfare gains (2%–3% relative to 1990 for the world, higher in Emerging and Developing countries), but that Preferential tariff cuts led to only small further gains (0%–1%). Surprisingly, the hypothetical movement to free trade leads to the greatest gains (5% relative to 1990, almost 10% in Emerging and Developing countries), which implies that there is strong scope for gains from future multilateral tariff reductions, especially for Emerging and Developing economies. These gains are large relative to prior estimates in the literature and we attribute about nearly one-half of our measured gains to selection effects in our heterogeneous-firm model, which are influenced by the scale of production and by two-tier Armington aggregation.

We analyze conventional and unconventional monetary policies in a dynamic small open-economy model with financial frictions. In the model, financial intermediaries or banks borrow from the world market and lend to domestic households. Banks can borrow abroad up to a multiple of their equity; in turn, there is a limit to how much bank equity households can hold. The combination of external and domestic frictions results in an economy-wide credit constraint and an endogenous interest rate spread. It also magnifies the amplitude and persistence of aggregate responses to exogenous shocks. In response to external balance shocks, fixed exchange rates are contractionary and flexible exchange rates expansionary (although less so in the presence of currency mismatches); the opposite is true in response to increases in the world interest rate. Unconventional policies, including central bank direct credit, discount lending, and equity injections to banks, have real effects only if financial constraints bind. Because of bank leverage, central bank discount lending and equity injections are more effective than direct credit. Sterilized foreign exchange intervention is equivalent to lending directly to domestic agents. Unconventional policies are feasible only to the extent that the central bank holds a sufficient amount of international reserves.

Whenever unemployment stays high for an extended period, it is common to see analyses, statements, and rebuttals about the extent to which the high unemployment is structural, not cyclical. This essay views the Beveridge curve pattern of unemployment and vacancy rates and the related matching function as proxies for the functioning of the labor market and explores issues in that proxy relationship that complicate such analyses. Also discussed is the concept of mismatch.

The Banque de France contribution analyzes the effect of liquidity risk on domestic and foreign lending, credit and intragroup funding by French banking groups. The paper finds that a higher core deposit ratio, a higher commitment ratio, and a low ratio of illiquid assets are associated with higher growth of certain types of lending during times of liquidity risk. These effects are mitigated when public liquidity is accessed, thus confirming that public liquidity provision was conducive to maintaining lending growth. Most importantly, it finds that the quantitative importance of liquidity risk is more pronounced for foreign lending, which may suggest that the particular banking model of French banks and the strong domestic retail sector contributed to the stability of domestic credit.