Monetary and fiscal integration in Europe

This thesis focuses on the consequences of European monetary integration and the associated coordination of fiscal policies. Initially, the euro appeared a resounding success. The global financial crisis of 2008/09 however hit the euro area hard and exposed severe macroeconomic imbalances within, and between, member states. To help understand the emergence of these imbalances, chapter 2 rewinds the clock to 1996, when, in anticipation of the introduction of the euro, interest rates started to sharply decline in many prospective Southern European member states. We show how falling rates sparked capital inflows, a domestic demand boom, and growth of the nontradable sector. Capital inflows did however not benefit the tradable sector, leading to a divergence between external debt and capacity to repay. Chapters 3 and 4 focus on fiscal policy coordination in EMU. In chapter 3, we highlight that the design of Europe’s fiscal rules encourages strategic behavior. More specifically, the official forecasts used to judge compliance with the rules tend to be overly optimistic when the 3%-threshold threatens to bind. Chapter 4 shows that, despite such side effects, Eurozone governments do actively tighten their fiscal policy in response to fiscal recommendations. Finally, chapter 5 zooms in on the euro crisis and its aftermath. We show that, during 2009-2012, shocks to Spanish and Italian sovereign spreads induced sizable spillovers to almost all other euro area countries. Since the announcement of the ECB’s Outright Monetary Transactions, such spillovers have largely disappeared, greatly enhancing the stability of the Eurozone as a whole