Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Discussion of

“On Ricardian Equivalence and Twin Divergence:The Spanish Experience in the 2009 Crisis”

by M. Cardoso and R. Doménech

Guido Ascari, University of Pavia

Banco de España Conference

“Interactions between monetary and fiscal policies”

Madrid, 25-26 February 2010

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Standard Structure

Praise of the paper

Summary of main results

Try to say something clever

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Praise

Very nice paper

Very rich model: REMS (Rational Expectations Model

of the Spanish economy). Big-scale DSGE NK model

with:

SOE in a monetary union

Two agents (credit constraints)

Search and matching frictions on the labor market

Public capital and energy in the production function

Public debt, various distortionary taxes and spending

(transfers, public expenditure/investment)

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Motivation: assess the effects of fiscal expansions in SE 3 exercises: increase in public consumption, public

investment and labor taxes

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Main result

Fiscal expansions cause only minor CA deficits

similar behaviour of

- Saving- private savings only partially offset the

movement in public savings, because Ricardian equivalence does not hold by construction

- Investment (crowding-out)

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Try to say something clever

Motivation

Model

Policy and results

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Motivation Explain the twin divergence observed during the recent crisis

“However, with the current economic crisis, the […] public budget surplus has turned into a huge deficit, […] the households saving rate has increased enormously,[…] and the current account deficit, […] is correcting very quickly.”

Current economic crisis is having big effects on Spain => great

policy relevance Subprime crisis…housing sector (boom and bust)…hh debt

Default risk and toxic assets…stock mkt and financial sector

Then banking crisis

Then real effects from “credit crunch”

There is nothing in the model that relates to the crisis: no

housing, no borrowing and lending, no credit, no banks

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Model

The spread

It maybe usual way “to close small open economy model”

Opposite direction to the current concerns regarding the PIIGS

especially relevant if one looks at the effects of fiscal policy and thus changes in national debt

…and only domestic residents hold domestic public debt

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Model

The labor contract: efficient Nash bargaining

“representative worker” surplus firm surplus

Earning premium of employment over unemployment

for a ROT and an optimizer

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Model

Public Investment

Increase in public investment => what happens to private savings?

Role of complementarity between the two capitals, i.e., Role of the assumption: public capital enters directly the production function?...

And what if foreign countries can finance public investment?

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Policy and Results

Assumption about the fiscal policy reaction function …here is based on lump-sum transfer realism??Why not exploit the rich structure of distortionary

taxes? which taxes gives the bigger effects?Corsetti et al. (2009)…importance of spending

reversal

Discussion of Cardoso and Doménech - Guido Ascari, University of Pavia

Policy and Results

The role of policy mix….(could not find TR parameter) robustness on monetary policy rule and parameters it may be less important in a monetary union, given

the small weight of the Spanish economy in EMU inflation

on the other hand, seems very accommodative, because the rate do not change

Crisis: the lower bound and the fiscal multiplier (Christiano et al., 2009)