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Optimal Fiscal Policy in a Monetary Union

Author

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  • Luisa Lambertini

    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

We study optimal fiscal policy in a monetary union where monetary policy is decided by an independent central bank. We consider a two-country model with trade in goods and assets, augmented with sticky prices, labor income taxes and stochastic government consumption. It is optimal to finance a shock in part by running deficits and in part by raising the labor income tax, even though the latter is distortionary. The optimal speed of adjustment of budget deficits is much higher than the benchmark adjustment of 0.5 percent of GDP per year required by the recent revision of the Stability and Growth Pact (SGP). Optimal fiscal policy does not depend on the initial level of public debt. Ramsey monetary policy allows for less aggressive and more expansionary response of fiscal policy than the monetary policy implied by an interest rates rule.

Suggested Citation

  • Luisa Lambertini, 2007. "Optimal Fiscal Policy in a Monetary Union," Working Papers 200801, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne.
    • Handle: RePEc:cif:wpaper:200801
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    File URL: http://infoscience.epfl.ch/record/109472/files/CFP2008_02.pdf
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    Cited by:

    1. Beetsma, Roel & Schabert, Andreas & Ribeiro, Marcos Poplawski, 2008. "A Comparison of Debt and Primary-deficit Constraints," CEPR Discussion Papers 6897, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Monetary Policy; Monetary Union; Fiscal Policy;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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