The EMU assigns a marginal role to economic policy and relies on the idea that, if prices are kept constant, there will be an automatic convergence towards long-run equilibrium income. These beliefs represent the theoretical underpinnings of fiscal and monetary policy strategies in Europe. In order to highlight the weakness of these foundations, this paper evaluates empirically the effects of public expenditure and interest rate setting on equilibrium income in Italy from 1998 to 2008. Our analysis supports the conclusions that government spending has a positive impact on national income while monetary policy strategy has a negative impact. Moreover, the high level of debt does not produce negative effects on GDP. Finally, at a time of financial crisis, these results are reinforced for fiscal policy, but weakened for monetary policy. The paper finally states that the EMU’s rigid rules for both fiscal and monetary policy have recessive outcomes.
Keywords: Fiscal Policy, Monetary Policy, EMU, Italy
Jel Code: E12, E52, E62