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This European Policy Analysis discusses the need to strengthen the institutions underpinning the euro and makes several policy recommendations. The Stability and Growth Pact must be reinforced, have greater automaticity and entail graduated sanctions. Fiscal surveillance must be improved through the establishment of a European Fiscal Stability Agency. Finally, the European Financial Stability Facility must be made permanent.
In my dissertation I study the transmission of monetary and fiscal policy in New Keynesian DSGE models. In the first chapter we revisit the exchange rate channel in a two-country model of the U.S. and a panel of industrialized countries to analyse how monetary policy transmission in the U.S. changes if it becomes more trade integrated. We find that more openness lowers the sacrifice ratio, although the effect is quantitatively small and depends on the pricing of the firms. In the second chapter we simulate the impact of the U.S. fiscal stimulus package in 2009 on GDP. We find that the government spendingmultiplier is well below 1. The finding is robust to including rule-of-thumb consumers and simulating the stimulus in the recent recession. In the third chapter we collect the fiscal stimulus measures in the eleven biggest countries of the euro area. Then we do a robustness study by simulating the european package in five different models of the euro area. The macroeconomic models vary in terms of backward-looking decision making of the agents and openness. Our findings provide no support for a Keynesian multiplier. Instead they suggest that additional government spending will reduce private spending for consumption and investment purposes. If government spending faces an implementation lag, the initial effect on GDP may even be negative. In the fourth chapter I estimate a DSGE model for Germany and compute forecasts for the debt-to-GDP ratio. I find that the expected economic recovery will lead to a decrease in Germany’s indebtedness in the medium-term given that policy makers stick to the fiscal policy rules.