We evaluate the effectiveness of a fiscal-monetary policy mix in the euro area, in response to the Covid-19 shock. It is assumed that the monetary union is made up of two symmetric regions. A fraction of households is subject to liquidity constraints and consumes all its available income in every period (another fraction has full access to financial markets and can smooth consumption in response to income fluctuations). We consider expansionary fiscal measures and non-standard monetary policy measures (asset purchases).
A fiscal expansion based on an increase in public consumption and transfers to liquidity-constrained households mitigates the recessionary effects of the Covid-19 shock, with positive spillovers across regions. Non-standard monetary policy amplifies the effectiveness of fiscal measures, by reducing long-term interest rates. The issuance by a supranational fiscal authority of a safe bond can avoid the insurgence of financial tensions, thus preserving the effectiveness of fiscal policy in the whole area.
Published in: Economic Challenges for Europe After the Pandemic, Springer Proceedings in Business and Economics, Berlin-Heidelberg, Springer
