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The Optimality of a Monetary Union Without a Fiscal Union

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  • Beetsma, Roel
  • Bovenberg, A Lans

Abstract

The paper explores the case for monetary and fiscal unification. Monetary policy suffers from an inflation bias because the monetary authorities are not able to commit. With international risk-sharing in a fiscal union, fiscal discipline suffers from moral hazard. An inflation target alleviates the inflation bias but weakens fiscal discipline. In a monetary union, however, this adverse effect on fiscal discipline is weaker. This advantage of monetary unification may outweigh the disadvantage of not being able to employ monetary policy to stabilize country-specific shocks. While monetary unification may thus be optimal, international risk-sharing may be undesirable because it weakens fiscal discipline.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1975.

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Date of creation: Sep 1998
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Handle: RePEc:cpr:ceprdp:1975

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Keywords: Fiscal Discipline; fiscal transfer scheme; Inflation Targets; Monetary Union; Moral Hazard;

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References

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  1. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  2. Beetsma, Roel M. W. J. & Lans Bovenberg, A., 1997. "Designing fiscal and monetary institutions in a second-best world," European Journal of Political Economy, Elsevier, vol. 13(1), pages 53-79, February.
  3. Sorensen, B-E & Yosha, O, 1996. "International Risk Sharing and European Monetary Unification," Papers 40-96, Tel Aviv.
  4. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
  5. Persson, Torsten & Tabellini, Guido, 1996. "Monetary Cohabitation in Europe," CEPR Discussion Papers 1380, C.E.P.R. Discussion Papers.
  6. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  7. Roger H. Gordon & A. Lans Bovenberg, 1994. "Why is Capital so Immobile Internationally?: Possible Explanations and Implications for Capital Income Taxation," NBER Working Papers 4796, National Bureau of Economic Research, Inc.
  8. Taylor, John B., 1983. "`Rules, discretion and reputation in a model of monetary policy' by Robert J. Barro and David B. Gordon," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 123-125.
  9. Svensson, Lars E O, 1997. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts," American Economic Review, American Economic Association, vol. 87(1), pages 98-114, March.
  10. Beetsma, Roel & Jensen, Henrik, 1997. "Inflation Targets and Contracts with Uncertain Central Banker Preferences," CEPR Discussion Papers 1562, C.E.P.R. Discussion Papers.
  11. Stanley Fischer, 1995. "Modern Approaches to Central Banking," NBER Working Papers 5064, National Bureau of Economic Research, Inc.
  12. Anne Sibert, 1996. "Monetary Integration and Economic Convergence," Archive Working Papers 030, Birkbeck, Department of Economics, Mathematics & Statistics.
  13. Jensen, Henrik, 1994. "Loss of monetary discretion in a simple dynamic policy game," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 763-779.
  14. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  15. Guy Debelle, 1996. "Central Bank Independence," IMF Working Papers 96/1, International Monetary Fund.
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