Comment 9: Comment on Chapter 13

Under EMU,monetary policy is oriented towards union-wide economic conditions, and cannot effectively address country-specific macroeconomic disturbances. Should national fiscal policy be used more actively, for stabilizing individual economies, now that exchange rate changes among member countries are no longer possible? Several recent studies answer this important normative question, based on sticky-price (New Keynesian) dynamic stochastic general equilibrium (DSGE) models with rigorous microeconomic foundations – see Galí and Monacelli (2008), Beetsma and Jensen (2005), Adão et al. (2006), Kirsanova et al. (2007), Ferrero (2007) and Forlati (2007). That research suggests that the adjustment of government purchases and tax rates in response to country-specific disturbances may noticeably improve economic welfare, in a monetary union; constraints on fiscal policy (ceilings on budget deficits or debt levels) can thus lower welfare. The research also shows that welfare-maximizing fiscal policy depends on the economic structure of the member countries, especially on the nature of market frictions and of shocks, and on what fiscal policy instruments can be used (spending or tax rates). However, rigorous analysis of these key issues is still in its infancy – the available studies use very stylized models. Research based on more realistic models is needed to permit reliable operational fiscal policy advice. The chapter by Christopher Allsopp andDavid Vines is an interesting contribution to the literature on fiscal policy in a monetary union. Its main merit is the use of a sticky-price DSGE model with a richer, more realistic policy transmission mechanism. A small economy in a monetary union is considered. The country’s government levies an income tax, purchases local goods, and issues debt. The tax rate is