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Potential Output and Fiscal Rules in a Monetary Union under Asymmetric Information 2nd ed

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  • L. Marattin
  • S. Meraglia

Abstract

We analyze fiscal rules within a Monetary Union in the presence of (i) asymmetric information on member states potential output and (ii) bail-out among member states. The first-best deficit is contingent on the cycle, that is, on member states output gap. In the presence of asymmetric information and bailout, the first-best deficit is not implementable. Bail-out lowers the scope for signalling (discrimination) by member states (lenders) and induces overborrowing by member states characterized by a low output gap. The Monetary Union can design a mechanism such that a member state with a smaller negative output gap runs an optimal budget deficit upon receiving a transfer form the Union. We show that, this cyclically-contingent fiscal framework Pareto dominates the cyclically-adjusted fiscal rule currently enforced by the European Monetary Union. Our model can then account for a situation where both asymmetric information over cyclical positions and the presence of bail-out among member states does not induce borrowing distortions.

Suggested Citation

  • L. Marattin & S. Meraglia, 2016. "Potential Output and Fiscal Rules in a Monetary Union under Asymmetric Information 2nd ed," Working Papers wp1063, Dipartimento Scienze Economiche, Universita' di Bologna.
    • Handle: RePEc:bol:bodewp:wp1063
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    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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