On Public Spending and Economic Unions

We analyze the conduct of fiscal policy in a financially integrated union presence financial frictions. Frictions create wedge between return to investment and interest rate. This leads an over-spending externality. While social cost spending is investment, governments care mostly about (depressed) rate they face. In other words, crowding-out effects public are partly “exported” rest union. argue that it may be hard for deal with this externality through design rules, which bound shaped by preferences median country not efficiency considerations. also how overspending externality—and union’s ability effectively—changes when world. Finally, we extend our model introducing zero lower on rates show that, if frictions severe enough, pushed into liquidity trap direction reversed. At such times, rules appropriate during normal times might backfire.