Fiscal Policy and External Constraint in the European Monetary Union

The European policy model was built upon the idea that state intervention has just a destabilizing role. The chapter puts in doubt this conclusion and connects fiscal crises with the balance of payments. A stylized model is presented. Its results are: 1) public expenditure can have positive effects not only on growth but also on deficit and debt if it is not accompanied by an a interest rate increase by the Central Bank; 2) when an external constraint is introduced fiscal policy can have negative effects if it comes with a balance of payment deficit. The same negative effects result from whatever shock causing negative expectation about the future growth of the national economy. The results suggest that to make a currency union work it is necessary to overcome national boundaries.