Fiscal policy in the EU in the crisis: a model-based approach

The current recession has proven to be the deepest and longest since the 1930s and recovery remains uncertain and fragile. But the general policy response to the downturn has been swift and decisive. Aside from government interventions dealing with the liquidity and solvency problems of the financial sector, the European Economic Recovery Plan (EERP) was launched in December 2008, in order to restore confidence and bolster demand through a coordinated injection of purchasing power into the economy. Governments across the world have implemented large fiscal stimulus packages.

Discretionary fiscal policy becomes more effective in the presence of credit constrained households. Rising credit constraints, and in many countries interest rate hitting their zero lower bound, made fiscal policy a more powerful tool in the recent credit crisis. However, many Member States in Central and Eastern Europe had very limited room to implement stimulus measures and often had to adopt consolidation measures with a view to avoiding a further fall-out from the crisis. Higher interest rates also meant that temporary fiscal stimuli in these countries were less effective than in countries where monetary policy could  accommodate the fiscal impulse. However, the authors István P. Székely, Werner Roeger and Jan in 't Veld of CASE Network Studies and Analyses No. 423 show, even when monetary policy cannot accommodate the fiscal impulse, well-designed fiscal stimulus measures can still help to soften the impact of the crisis and mitigate the detrimental effects on (potential) growth.