On the fiscal consolidation in open economies

The relationship between fiscal policy and international trade, and their implications on economic growth, has not been widely discussed. The effects of fiscal policy on growth is a classical topic in economics, and we also can find research relating external openness and economic growth; but the extent to which fiscal policies could affect commercial policies, competitiveness and the trade balance is a question that has not yet been answered by the literature. The purpose of this paper is to study the relationship between the government balance and the current account in the scenario of a monetary union where fiscal consolidation is constrained by the fiscal discipline imposed by supranational agreements. 

To that end, we will try to examine the consequences of government balance on trade balance under alternative monetary agreements (and/or different exchange rate regimes). First, we develop a simple two-country model in order to analyse in strategic terms how the authorities can deal with fiscal and trade shocks when there are no restrictions in using the exchange rate and monetary policy as instruments of macroeconomic stabilization. Next, we compare the results with the case of a monetary union. In particular, we would evaluate the costs of losing independence in the use of the exchange rate and monetary policy, and the restrictions derived from the fiscal discipline required for supporting monetary agreements. In this way, we would be able to show to what extent different monetary agreements (and/or different exchange rate regimes) would affect macroeconomic policy decisions when facing trade shocks.