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How Do Monetary and Fiscal Policy Interact in the European Monetary Union?

In: NBER International Seminar on Macroeconomics 2004

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  • Matthew B. Canzoneri
  • Robert E. Cumby
  • Behzad T. Diba

Abstract

Formation of the Euro area raises new questions about the coordination of monetary and fiscal policy. Using a New Neoclassical Synthesis (NNS) model, we show that a common monetary policy, responding to area-wide aggregates, has asymmetric effects on countries within the union, depending on whether they are large or small, or whether they have high or low debts. We analyze the implications of these asymmetries for the various countries welfare and for their fiscal policies. We also study rules for setting national tax and spending rates, rules that constrain movements in the deficit to GDP ratio. We ask whether these rules are necessary for the common monetary policy to be able to harmonize national inflation rates, and we analyze their effects on national welfare. We also discuss some potential failings of our model (and perhaps NNS models generally); in particular, our model's variance decompositions suggest that productivity shocks may play an inordinately large role, while fiscal shocks (or demand shocks generally) may play too small a role (even when 'rule of thumb' spenders are added).

(This abstract was borrowed from another version of this item.)

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This chapter was published in:

  • Richard H. Clarida & Jeffrey Frankel & Francesco Giavazzi & Kenneth D. West, 2006. "NBER International Seminar on Macroeconomics 2004," NBER Books, National Bureau of Economic Research, Inc, number clar06-1, octubre-d.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0078.

    Handle: RePEc:nbr:nberch:0078

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Jordi Galí & J. David López-Salido, 2003. "Understanding the Effects of Government Spending on Consumption," Working Papers 73, Barcelona Graduate School of Economics.
    2. Surico, Paolo, 2003. "How does the ECB target inflation?," Working Paper Series 0229, European Central Bank.
    3. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
    4. Margarida Duarte & Alexander L. Wolman, 2002. "Regional inflation in a currency union: fiscal policy vs. fundamentals," International Finance Discussion Papers 746, Board of Governors of the Federal Reserve System (U.S.).
    5. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
    6. Harris Dellas & Fabrice Collard, 2004. "Inflation targeting," Computing in Economics and Finance 2004 97, Society for Computational Economics.
    7. Robert Kollmann, 2004. "Welfare Maximizing Monetary and Fiscal Policy Rules," Computing in Economics and Finance 2004 102, Society for Computational Economics.
    8. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
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    Cited by:
    1. Andrea Ferrero, 2005. "Fiscal and Monetary Rules for a Currency Union," Macroeconomics 0508020, EconWPA.
    2. PLASMANS, Joseph & FORNERO, Jorge & MICHALAK, Tomasz, 2006. "A microfounded sectoral model for open economies," Working Papers 2007013, University of Antwerp, Faculty of Applied Economics.
    3. Ludger Linnemann & Andreas Schabert, 2004. "Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability," Working Paper Series in Economics 12, University of Cologne, Department of Economics.
    4. Pappa, Evi & Vassilatos, Vanghelis, 2007. "The unbearable tightness of being in a monetary union: Fiscal restrictions and regional stability," European Economic Review, Elsevier, vol. 51(6), pages 1492-1513, August.
    5. Margarida Duarte & Alexander L. Wolman, 2003. "Fiscal policy and regional inflation in a currency union," Working Paper 03-11, Federal Reserve Bank of Richmond.
    6. Oliver Grimm & Stefan Ried, 2007. "Macroeconomic Policy in a Heterogeneous Monetary Union," SFB 649 Discussion Papers SFB649DP2007-028, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    7. Lipińska, Anna & von Thadden, Leopold, 2009. "Monetary and fiscal policy aspects of indirect tax changes in a monetary union," Working Paper Series 1097, European Central Bank.
    8. Duarte, Margarida & Wolman, Alexander L., 2002. "Regional inflation in a currency union: fiscal policy vs. fundamentals," Working Paper Series 0180, European Central Bank.
    9. repec:dgr:uvatin:2005077 is not listed on IDEAS

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