Marrying Fiscal Rules & Investment: a Central Fiscal Capacity for Europe

42 Pages Posted: 15 Apr 2024

See all articles by Christopher Schang

Christopher Schang

European University Institute - Economics Department (ECO)

Francesca Vinci

European Central Bank (ECB)

Date Written: March 20, 2024

Abstract

The European fiscal governance framework remains incomplete, leading to challenges in coordinating policy responses when facing economic shocks, and hampering the transmission of the single monetary policy. Moreover, high public debt burdens, coupled with pro-cyclical and chronically low public investment in the face of high investment needs hamper resilience across Member States. Several policy-makers, institutions and academics hence share the view that the establishment of a central fiscal capacity (CFC) would be an important step forward. Against this backdrop, we provide a framework to assess a proposal for a CFC in the euro area, aimed at stabilizing the business cycle, promoting sovereign debt sustainability as well as reducing the procyclicality of public investment. We develop a two-region DSGE model with a permanent CFC that allocates resources based on the relative output gap of the two regions while earmarking a fraction for public investment and imposing fiscal adjustment requirements for the high-debt region. We find that the introduction of the CFC can lead to enhanced business cycle stabilisation and welfare improvements for both regions. In response to an asymmetric shock, the CFC reduces procyclicality in public investment and tames the public debt burden. The analysis also explores modelling extensions to enable European bond issuance and implement an active supranational investment strategy to address investment needs by providing European Public Goods (EPGs).

Keywords: Central Fiscal Capacity, European Fiscal Rules, Public Investment, Fiscal Policy, Macroeconomic Stabilisation, European Bonds, European Public Goods.

JEL Classification: E12, E32, E62, F45

Suggested Citation

Schang, Christopher and Vinci, Francesca, Marrying Fiscal Rules & Investment: a Central Fiscal Capacity for Europe (March 20, 2024). Available at SSRN: https://ssrn.com/abstract=4766347 or http://dx.doi.org/10.2139/ssrn.4766347

Christopher Schang

European University Institute - Economics Department (ECO)

Via delle Fontanelle, 18
Fiesole, FI 50014
Italy

Francesca Vinci (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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