Killing two birds with one currency: Income and fiscal policies in a growth model of a currency union

Abstract

Building on a two-country Kaleckian model of a currency union, we examine the consequences of balance-of-payments adjustment policies, focusing on the interdependence between the long-run growth paths of member countries. The model separates the short-run from the long-run dynamic, comparing price and wage dynamics in each country in the light of Thirlwall’s balance-of-payments-constrained growth model. We show that by shifting the burden of adjustment to the less competitive country, austerity and wage moderation policies lead to long-term recessionary effects. Only expansionary policies in the more competitive country can achieve the two goals of reducing external imbalances and increasing the long-run growth rate in both member countries.

Keywords:

• Austerity
• BoP-constrained growth model
• monetary union
• trade interlinkages
• two-country Kaleckian model
• wage moderation

JEL CLASSIFICATIONS:

• E12
• E62
• E64
• F43
• F45

Notes

1 This markup behavior builds on the “profit squeeze” literature (Glyn and Sutcliffe 1972; Milberg and Arestis 1993–1994).

2 If we ignore interest payments, the long-run equilibrium is not affected even when $F^{*}\ne 0.$

3 Note that we distance ourselves from the standard modelization of markups in the post Keynesian literature, where markup behavior results from the bargaining power of workers in their negotiations with firms (Bastian and Setterfield 2015; Cassetti 2003, 2006; Lavoie 2014, Chapter 8).

4 A recent mainstream interpretation related to recent labour market theories is provided by Blanchard and Giavazzi (2003).

5 Taking workers’ propensity to save $s_w$into account does not modify this result, provided that $s_C-s_w>{\alpha }_i$ (see Lavoie 2014, Chapter 6). This condition is found to be consistent with empirical data (Mott and Slattery 1994).

6 In Figure 5 we assume that ε₁ and ε₂ are greater than one, but the same results apply for every positive value of ε₁ and ε₂ provided that ${\epsilon }_1> {\epsilon }_2.$

7 In terms of the euro area, Country 1 can be likened to deficit countries (southern Europe), and Country 2 to surplus countries (northern Europe). In this respect, our article contributes to the large body of literature that analyzes the euro area using two-regions models (e.g., Benigno 2004; Corsetti et al. 2014).

8 The nonlinearity of the system prevents a closed-form representation of the solution.

Additional information

Notes on contributors

Alberto Bagnai

Alberto Bagnai is an Associate Professor of Economic Policy in the Department of Economics, University ‘Gabriele D’Annunzio.’, Pescara, Italy.

Arsène Rieber

Arsène Rieber is a Professor of Economics in the Faculty of Law, Economics and Management, CREAM, University of Rouen., Mont-Saint-Aignan, France.