The objective of the research is to study the effectiveness of the current monetary and fiscal policy mix to jump start Europe after the pandemic shock. The EU has reacted in an unprecedented way to the COVID shock through a combination of expansionary monetary and fiscal policies. This policy mix is new and different from that used in the aftermath of the financial crisis which was mainly relying on monetary policy. The ECB activated the Pandemic Emergency Purchasing Program (PEPP); the EU Council and the EU Commission suspended the Stability Pact, eased the possibility of state aids (see the various versions of the Temporary Framework), approved various initiatives at the euro-area level (e.g. SURE), and launched a new program, Next Generation EU (NGEU), to sustain investment and the recovery.
The objective of the research is to study the effectiveness of the current monetary and fiscal policy mix, its potential trade-offs and risks, focusing on distributional issues and political economy considerations that can affect its implementation.
The proposal can be divided into four themes that will be pursed in an organic and coordinated way: 1) Monetary policy stimulus: study the effectiveness of PEPP compared with alternative strategies, like helicopter money and enhanced forward guidance; analyze sovereign-debt risk due to the unwinding of PEPP; 2) Fiscal policy stimulus: provide a quantitative assessment of structural investments both from a micro and a macro perspective, by developing a new generation of models that integrate the macro dynamic approach with the fiscal microsimulation; 3) Reallocation effects of public investment across sectors: investigate reallocation effects and cross-sectional spillovers of new technologies adoption, skill-biased technological change and capital-skill complementarities. 4) Policy recommendation: identify a set of policy recommendations that should drive the post-COVID recovery.
The expected outcomes of the four themes of the project can be outlined in the following way.
1) Monetary policy stimulus. The aim to contribute to our knowledge of the effectiveness of the PEPP program in comparison with new monetary tools or with the refinement of already used ones that can be deployed to further stimulate the economy. The focus is on helicopter money policy, on how forward guidance can enhance the Asset Purchase Programs (APPs) and on APPs possible drawbacks once their unwinding could put sovereign debt solvency at risk.
2) Fiscal policy stimulus. The expected outcome is a quantitative assessment of public investment stimulus. The analysis will start from a detailed characterization of microeconomic effects, that will then be aggregated into a coherent macro model. The key features of this model are the time-to-spend and time-to-built assumptions, the distinction between tangible and intangible public capital (with the latter affecting the endogenous growth by R&D), the formalization of a variable public investment elasticity to consider different qualitative composition in the fiscal plans. Moreover, we plan to develop a new generation of models as a bilateral integration of the macro dynamic approach with the fiscal microsimulation to coherently account for the distributive issues and the impact of aggregate expectations. The proposed models should help the policymaker and researchers to better understand the tradeoffs at stake, and to investigate monetary and fiscal coordination, the NGEU sustainability, the EU post-pandemic resilience.
3) Reallocation effects of public investments. We investigate the sectorial reallocation of public investments designed to favor digitalization. Based on the assumption that a complementarity exists between public investment and the adoption of new technologies, the key research question concerns the consequences that arise in terms of firms¿ monopolistic power, capital intensity and labor substitution, and the wage premium of skilled workers. The ultimate goal is to address the challenge of designing policies that complement efficiency-oriented public investments and preserve an equitable distribution of the growth dividend. In this regard, the project will contribute: a) a better understanding of how public investment plans aimed at fostering the digital and green transition might succeed in stimulating growth, expanding a literature that essentially treats public capital as an addendum to the aggregate neoclassical supply function; b) an analysis of the redistributive effects of NGEU when public infrastructure investment triggers skill-biased technological change and when capital-skill complementarity is heterogeneous across workers.
4) Policy recommendation. The expected outcome is to identify a set of policy recommendations that should drive the post-COVID recovery. In this respect, the unifying assumption is that the post-pandemic economic systems, and specifically the EU, will not simply reproduce the previous organizational and institutional settings. For instance, the possible success of NGEU would start a process of gradual fiscal unification opening new perspectives in the combination between monetary and fiscal policies.