In the literature on Public Economics and Macroeconomic Theories, fiscal policy has been viewed as an effective tool for achieving stabilization. Nowadays, in the environment of the current economic crisis, the debate on the role of economic policies has developed a renewed interest in an attempt to offer solutions to help economies recover after the crisis. Among others, the coordination of fiscal and monetary policy; the deficit and debt reduction, the measurement of output responses to fiscal policies, and a more active role of fiscal policy have been recommended as ways of contributing to improve fiscal policy effectiveness. Those questions become particularly relevant in the case of the member countries of a monetary union facing a sovereign debt crisis, given that fiscal policy is constrained by the need to carry out fiscal consolidation and reduce debt levels. In monetary unions, monetary policy is insufficient to achieve the required stabilization, and if monetary authorities are particularly interested in controlling inflation and stabilizing output, the fiscal authorities are expected to ensure sound fiscal policies but also to help guarantee price stability.
In this paper, aimed to examine the macroeconomic effects of fiscal policies within a monetary union, we will develop a simple model for a monetary union to analyse different combinations of fiscal policies using explicit policy rules. We will allow for a more or less conservative governor of the central bank, we will also consider both austere and no austere fiscal policy and, finally, we will take into account the initial level of public debt of the member countries of the union. Next, for evaluating the macroeconomic implications of the optimal fiscal policies, we will calculate changes in government deficit, output, inflation and unemployment.
When calculating these changes, the results reveal that in heterogeneous monetary unions, a coordinated solution is not always welfare improving. This result, related to the initial level of public debt, is robust to different choices of fiscal rules.
