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