Fiscal Federalism in the EMU

With a common monetary policy and interest rate in a currency area, optimal policy mix entails a very active stabilization role of fiscal policy. Such a role however, requires supporting each other’s actions of all member states. This paper contributes to the on-going debate on optimal macroeconomic policy in the EMU by analysing the effects that would stem from implementing a Pan-European fiscal coordination mechanism. Our results have proven the substantial welfare benefits of fiscal coordination. The bigger and less asymmetric shocks affecting the members of the monetary union, the larger the welfare gains. Sample estimates for the EMU Member States show that introducing an efficient coordination mechanism would bring gains in the increase of consumption by 2.8 to 4.6%.