International Macroeconomics – exchange rate policy, risk sharing and financial compensation systems

The union of different European states with individual preconditions and macroeconomic challenges under a common currency and monetary policy requires solutions on how to deal with economic distortions and shocks that affect member states asymmetrically and where price mechanisms, factor mobility and integrated financial markets do not work sufficiently to mitigate risks. Since the start of the European Monetary Union, there have been repeated calls for a reform of the fiscal framework, probably necessary at the latest since the Corona pandemic with the NextGenerationEU program and the euro bonds. Although originally explicitly considered in the conception of the European Monetary Union (Delors Report of 1989), fiscal transfer schemes or federal fiscal structures are not discussed in the reform proposals.

In this research project, we analyze different fiscal transfer schemes for managing asymmetric cyclical patterns in a monetary union. We ask about macroeconomic effects and risk sharing properties going from simple transfers to full fiscal federalism. We focus on the insurance and welfare effects of explicit and implicit transfer mechanisms. We also consider possible adverse incentives of Union-wide equalization mechanisms on the fiscal behaviour of sovereign member countries: Does a transfer system fuel inefficient taxation and unintended fiscal side effects? Does fiscal federalism reduce individual risk provisions of member countries? Does a common debt lead to excessive budget deficits in individual member countries?

Another topic is the reciprocal relationship between central banks. The central bank influences the price ratio of exports and imports – the terms of trade – and thus directly affects foreign trade via exchange rate policy. This influence on foreign trade leads to a number of questions: What is the incentive of sovereign monetary policy to manipulate exchange rates in self-interest? Does this strategic incentive lead to systematic inflation distortions? What would cooperation look like to avoid these adverse incentives, and what role does fiscal policy then play?

Michael P. Evers, Julius Kraft, Victoria Krautter

Research contributions:

Fiscal Backlash to International Monetary Policy Coordination

Michael P. Evers (2016)

Fiscal Federalism and Monetary Unions: A Quantitative Assessment

Michael P. Evers (2015, Journal of International Economics, 97 (1), 59-75)

Strategic Monetary Policy in Interdependent Economies: Gains from Coordination Reconsidered

Michael P. Evers (2013, Journal of International Money and Finance, 32, 360-376)

Federal Fiscal Transfer Rules in Monetary Unions

Michael P. Evers (2012, European Economic Review, 56 (3), 507-525)

Federal Fiscal Transfers in Monetary Unions: A NOEM Approach

Michael P. Evers (2006, International Tax and Public Finance (Special Issue), 13 (4), 463-488)