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The purpose of this article is to demonstrate that a common fiscal policy, designed to support the euro currency, has some significant drawbacks. The greatest danger is the possibility of leveling the tax burden in all countries. This leveling of the tax is to the disadvantage of countries in Eastern Europe, in principle, countries poorly endowed with capital, that use a lax fiscal policy (Romania, Bulgaria, etc.) to attract foreign investment from rich countries of the European Union. In addition, common fiscal policy can lead to a higher degree of centralization of budgetary expenditures in the European Union.

This paper derives and estimates rules for fiscal policy that prescribe the optimal response to changes in unemployment and debt. We combine the reduced form model of the economy from a linear VAR with a non-linear welfare function and obtain analytic solutions for optimal policy. The variables in our reduced form model –growth, unemployment, primary surplus– have a natural rate that cannot be affected by policy. Policy can only reduce fluctuations around these natural rates. Our welfare function contains future GDP and unemployment, the relative weights of which determine the optimal response. The optimal policy rule demands an immediate and large policy response that is procyclical to growth shocks and countercyclical to unemployment shocks. This result holds true when the weight of unemployment in the welfare function is reduced to zero. The rule currently followed by policy makers responds procyclically to both growth and unemployment shocks, and does so much slower than the optimal rule, leading to significant welfare losses.

Sweden is a front-runner in defining intermediate targets for fiscal policy (fiscal rules) as well as in setting up an independent fiscal council to monitor and comment on developments. Swedish public finances are among the most sound in the OECD having been able to consolidate public finances and ensure fiscal sustainability, and they have maintained room for fiscal manoeuvre also during the financial crisis. This paper takes a closer look at the Swedish case as the stepping stone for a more general discussion of how to set intermediate targets for fiscal policy and the role fiscal councils may have in strengthening political accountability and thus ultimately credibility of fiscal policy. The Swedish fiscal framework is compared to the fiscal compact for EU countries, and it is argued that it has a number of desirable features.

This dissertation, comprising three academic papers, deals with the trade-off between fiscal sustainability and macroeconomic stabilization. The first paper examines the specification of fiscal reaction functions: We argue that the fiscal response to public debt is varying over time, finding formal empirical evidence in favor. We then link this non-linear fiscal response to changes in the interest rate-growth differential and the level of public debt. The second paper takes time-varying parameter fiscal reaction functions to an out-of-sample forecast performance evaluation, embedding it in ...

This dissertation, comprising three academic papers, deals with the trade-off between fiscal sustainability and macroeconomic stabilization. The first paper examines the specification of fiscal reaction functions: We argue that the fiscal response to public debt is varying over time, finding formal empirical evidence in favor. We then link this non-linear fiscal response to changes in the interest rate-growth differential and the level of public debt. The second paper takes time-varying parameter fiscal reaction functions to an out-of-sample forecast performance evaluation, embedding it in ...