The rationale for a safe asset and fiscal capacity for the eurozone

The chapter introduces a standard Mundell-Fleming framework adapted to the features of a closed monetary union, with a two-country setting comprising a “core” and a “periphery” country, to evaluate the response of policy and the economy in case of symmetric and asymmetric demand and supply shocks in the current situ- ation and following the introduction of safe bonds and fiscal capacity. Under the specified assumptions, it concludes that a safe asset and fiscal capacity, better if in combination, would remove the doom loop between banks and sovereigns, reduce the loss in output for both economies and improve the stabilisation properties of fiscal policy for both countries, and thus is welfare enhancing.