Working Papers

The aim of the Working Papers series is to disseminate research papers on economics and finances by Banco de España researchers. The Working Papers are published once they have successfully come through an anonymous evaluation process. Through their publication, the Banco de España seeks to contribute to the economic analysis and knowledge of the Spanish economy and its international context.

The opinions and analyses published in the Working Papers series are the responsibility of the authors and are not necessarily shared by the Banco de España or the Eurosystem.

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  • 2001
    Debt sustainability and fiscal space in a heterogeneous Monetary Union: normal times vs the zero lower bound   File PDF: Opens in a new window (661 KB) Javier Andrés, Pablo Burriel and Wenyi Shen

    In this paper we study fiscal policy effects and fiscal space for countries in a monetary union
    with different levels of public debt. We develop a dynamic stochastic general equilibrium
    (DSGE) model of a two-country monetary union, calibrated to match the characteristics of Spain and Germany, in which debt sustainability is endogenously determined a la Bi (2012) to shape the responses of the risk premium on public debt. Policy shocks change the market’s expectation about future primary surplus, producing a direct effect on the sovereign risk premium and macroeconomic responses of the economy. In normal times the costs of a government spending driven fiscal consolidation in the high-debt country are greatly diminished when this consolidation improves endogenously its debt sustainability prospects. Fiscal consolidations in both members of the monetary union decrease real interest rates and amplify the reduction in risk premium in the highly-indebted country, improving union-wide output in the long run, but at the cost of lower output in the low-debt country in the short term. On the contrary, when monetary policy is constrained at the zero lower bound, the risk premium channel arising from the endogenous determination of debt sustainability becomes muted. In the ZLB, a fiscal consolidation generates deflation expectations which increase the real interest rate and may compensate partially or completely, depending on the calibration, the benefits from a lower risk premium. In this context, a fiscal expansion in the low-debt country and a consolidation in the high-debt country delivers the greater positive impact on union-wide output. Finally, the risk premium channel only affects countries with medium or low levels of public debt indirectly through the negative spillovers from other high-debt members of the monetary union.

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