Author Archives: Pekka Vanhala

New journal article published: Government debt deleveraging in the EMU

Alexandre Lucas Cole, Chiara Guerello & Guido Traficante (2023), Government debt deleveraging in the EMU, International Economics, Volume 173, May 2023, Pages 296-324,

We evaluate the stabilization properties of several rules and instruments to reduce government
debt in a Currency Union, like the EMU. In a two-country New-Keynesian DSGE model, with
a debt-elastic government bond spread and incomplete international financial markets, we
study the effects of government debt deleveraging, under different scenarios for fiscal policy
coordination. We find that greater stabilization is achieved when the two countries coordinate
by stabilizing net exports. Moreover, we find that taxes are a better instrument for deleveraging
compared to government transfers. Our policy prescriptions for the Euro Area are to reduce
government debt less during recessions and liquidity traps, and to do so using distortionary
taxes, while concentrating on reducing international demand imbalances.

Published version:
Free access pre-print version:


New article published: Cross-country fiscal policy spillovers and capital-skill complementarity in integrated capital markets

Thomas Davoine & Matthias Molnar (2020), Cross-country fiscal policy spillovers and capital-skill complementarity in integrated capital markets, Economic Modelling, Volume 88, 2020, Pages 132-150, ISSN 0264-9993,



The 2010 European sovereign debt crisis has renewed discussions on fiscal policy coordination. One rationale for coordination is fiscal policy cross-country spillovers. A common finding in the literature is that spillovers tend to be small in normal circumstances but can be large if monetary policy is at the zero lower bound. Orthogonal to the existing literature, we document a novel channel that generates cross-country spillovers over the medium run. We assume perfect capital markets integration and find that capital-skill complementarity can lead to large spillovers without the zero lower bound nor a large import share in government expenditures. As capital markets have become increasingly integrated in the Eurozone, the current degree of fiscal policy coordination between its members, low, may be insufficient. We also find that the smoothing benefits from a temporary rise in public debt spill over to other countries.


New journal article published: ONE EMU FISCAL POLICY FOR THE EURO

Cole, A., Guerello, C., & Traficante, G. (n.d.). ONE EMU FISCAL POLICY FOR THE EURO. Macroeconomic Dynamics, 1-41. Published online by Cambridge University Press: 26 November 2019. doi:10.1017/S1365100518000925.


We build a two-country New-Keynesian DSGE model of a Currency Union to study the effects of fiscal policy coordination, by evaluating the stabilization properties and welfare implications of different fiscal policy scenarios. Our main findings are that a government spending rule which targets the net exports gap rather than the domestic output gap produces more stable dynamics and that consolidating government budget constraints across countries with symmetric tax rate movements provides greater stabilization. A key role is played by the trade elasticity which determines the impact of the terms of trade on net exports. In fact, when goods are complements, the stabilization properties of coordinating fiscal policies are no longer supported. These findings point out to possible policy prescriptions for the Euro Area: to coordinate fiscal policies by reducing international demand imbalances, either by stabilizing trade flows across countries or by creating some form of Fiscal Union or both.

An Open Access version is available at MPRA


Rethinking the governance of economic and monetary union: Should rules continue to rule?

Although the EU economy has returned to a period of stable growth since the Eurozone crisis, several key issues in the governance of economic and monetary union remain unresolved. Drawing on results from the Firstrun project, Iain Begg provides an overview of current concerns and outlines five recommendations to help further the debate.

Read Iain Begg’s blog at


Summary report of the FIRSTRUN project published

The last FIRSTRUN deliverable, D1.7 Summary report of the FIRSTRUN project has been published today.

Executive summary:

FIRSTRUN, or Fiscal Rules and Strategies under Externalities and Uncertainties, is a Horizon 2020 project that has investigated fiscal policy coordination in the EU. This report provides a brief overview of the project and its key findings.

One important research theme of the project has been the effects of cross-country spillovers from economic policies. In addition to spillovers from changes in the level of government spending or taxation, which influence aggregate demand, the project has studied spillovers from “structural fiscal policies”, such as pension reforms, which influence the supply side of the economy.

Both the empirical and model-based results are in line with the view that during “normal times”, fiscal spillovers from changes in the level of government spending or taxation are relatively small. However, spillovers may be much larger during “crisis times”, when the borrowing of many households is constrained and when monetary policy is also possibly constrained by the (effective) zero lower bound. Spillovers also increase when national fiscal policies are coordinated. These results underline the importance of fiscal coordination under special circumstances.

Certain structural reforms also have non-trivial spillover effects via international capital markets. These spillovers do not necessarily require policy coordination from the efficiency point of view, but they do have redistributive implications, e.g. their effects on the extent to which capital market integration benefits different countries.

A related issue is how exactly fiscal policies should be coordinated in a currency union to stabilise output growth and maximise average welfare. The analysis, based on a two-country DSGE-model characterised by country-specific price rigidities and distortions, suggests that the optimal solution would be to use fiscal policies to reduce net export gaps. This result stems from country-specific nominal price rigidities, which imply destabilising fluctuations in the terms of trade over the business cycle.

Another stabilization mechanism relates to cross-country risk-sharing. The FIRSTRUN project has considered private and public risk-sharing mechanisms and compared cross-country risk-sharing in the Economic and Monetary Union (EMU) to risk-sharing across states in the United States. The results show that there is still relatively little cross-country risk-sharing via private capital markets in the EMU. One reason for this is that the cross-border ownership of productive assets remains very limited.

The project has also paid close attention to what is known as “real-time uncertainty”, i.e. uncertainty about the current state of the economy. Real-time uncertainty appears to be very relevant for fiscal policy, because it is particularly difficult to distinguish between cyclical and structural components in economic growth in real time. As a result, the first estimates of variables such as the output gap or the structural deficit, which are key variables to consider when setting the stance of fiscal policy, are often later substantially revised. This has important implications for the optimal fiscal policy as well as the implementation of various EU fiscal rules.

A large part of the FIRSTRUN research was dedicated to evaluating the new, enhanced framework of EU fiscal governance. For example, the approach has been to consider how the new fiscal rules would have constrained fiscal policies during past economic booms and busts. Such analysis requires a clear and comprehensive view of the information that was available at the time the rules would have been applied.

In this regard, one of the main results is that the use of the structural deficit for steering fiscal policy tends to lead to pro-cyclical fiscal policy. Essentially, this is because the output gap method used to assess the structural deficit has a very limited capacity to track cyclical changes in real time.

The project also considered alternative measures for estimating the structural balance, such as the expenditure rule used in the preventive arm of the Stability and Growth Pact (SGP) and the so-called bottom up assessment method used in the corrective arm. The results show that at least in the past, these methods would have been conducive to better fiscal policy than the output gap method.

In a similar vein, FIRSTRUN researchers analysed whether the Macroeconomic Imbalance Procedure (MIP) would have been able to detect increasing macroeconomic risks prior to the 2008 financial crisis and the subsequent recession. The results show that the MIP would have provided moderately useful alerts in terms of crisis prediction before 2009. However, many of the indicators, especially those related to the financial markets, would have been uninformative. This suggests that the MIP Scoreboard could be simplified.

The project also dealt with political and institutional aspects of EU fiscal governance. It raised concerns regarding the erosion of democratic legitimation in EU fiscal governance. Given that fiscal policy has more direct distributive consequences than other areas of policy which have become more technocratic, this may undermine the implicit contract between voters and national governments. In addition, public trust in decision-makers has been shaken. The concept of throughput legitimacy – validating how the EU level decides on the policy demands to be made on member countries – is suggested as one dimension of legitimation to be explored.

Finally, the project has produced new tools in the form of quantitative economic models for designing fiscal policies and developing fiscal coordination mechanisms in the EU.


FIRSTRUN Final Conference 29 Jan 2018

FIRSTRUN Final Conference at CEPS on 29 January 2018:
The Future of EU Fiscal Governance: Stabilisation, rules and spillover effects

Over the course of the past three years, a consortium of prestigious universities and economic policy institutes has worked together to carry out research under the FIRSTRUN project. The research team has produced a large body of scientific papers and policy analysis intended to actively contributing to the debate on EU economic governance.

This conference is an opportunity to present selected outputs of the FIRSTRUN project aiming at better understanding how the current EU governance system works as well as discussing potential changes. The conference comes at a very timely moment when the European Commission will be putting forward a more detailed view about the future of EU economic governance. This view will be presented during the conference by Marco Buti, Director-General for Economic and Financial Affairs at the European Commission.


Keynote: Marco Buti (DG ECFIN): The future of the EU fiscal governance

Tero Kuusi (ETLA): Estimating the output gap in real time: Top-down vs. bottom-up

Cinzia Alcidi (CEPS): Shock absorption in the euro area

Rebecca Piggott (NIESR): Fiscal policy spillovers in NiGEM

Thomas Davoine (IHS): Spillover effects from ageing and structural reforms

Alexandre Lucas Cole (LUISS): Fiscal policy coordination and deleveraging

Maria Siranova (IER SAS): The predictive power of the MIP Scoreboard’s indicators

Iain Begg (LSE): Are fiscal and other macroeconomic policy rules past their ‘sell-by’ date?


Video streams:

Keynote by Marco Buti (DG ECFIN) [slides]

The panel discussion led by Daniel Gros on Fiscal rules & Market discipline


* * *

Also see the CEPS website

Full agenda