Potential Output and Fiscal Rules in a Monetary Union under Asymmetric Information

Marattin, Luigi ; Meraglia, Simone (2015) Potential Output and Fiscal Rules in a Monetary Union under Asymmetric Information. Bologna: Dipartimento di Scienze economiche DSE, p. 24. DOI 10.6092/unibo/amsacta/4312. In: Quaderni - Working Paper DSE (1018). ISSN 2282-6483.

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We analyze fiscal rules within a Monetary Union in the presence of (i) asymmetric information about member states’ potential output and, therefore, output gap and (ii) bail-out among member states. In our framework, bail-out lowers the scope for signalling (discrimination) by member states (lenders). In the presence of asymmetric information, bail-out and national governments’ shortsightedness make the first-best fiscal rule non-implementable as member states are tempted to run excessively high deficits. The Monetary Union designs a mechanism such that member states with high output gap (i.e., in a recession) run higher budget deficits by making an ex-post transfer to the Union. We find that the first-best deficit is contingent on the cycle – i.e., on the member state’s output gap – and, all else equal, can be implemented provided the member states’ ability to repay its own debt upon the realization of a bad shock is sufficiently high. A downward distortion in the deficit run by a member state during an expansion is otherwise introduced. Finally, the Monetary Union cannot discriminate among types of borrowers when national governments are excessively shortsighted.

Document type
Monograph (Working Paper)
Marattin, Luigi
Meraglia, Simone
Monetary Union, Output Gap, Asymmetric Information, Bail-Out, Fiscal Rules
Deposit date
27 Jul 2015 09:11
Last modified
23 Oct 2015 09:04

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