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Fiscal Stabilization Policy in a Monetary Union with Inflation Targeting

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  • Andersen, Torben M
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    Abstract

    The interaction between a common monetary policy targeting inflation and decentralized fiscal policies aiming at output stability is considered in a setting taking into account interdependencies between countries running via trade links and the common monetary policy. The setting is sufficiently general to capture various effects of fiscal policy, and to allow for both demand and supply shocks, which can be either aggregate or idiosyncratic. It is shown that a policy mix problem arises between the common monetary policy and the decentralized fiscal policy, which results in an inappropriate stabilization of shocks. In the case of aggregate shocks the inefficiency in responding to shocks is increasing in the number of member countries, while it is decreasing in the case of idiosyncratic shocks. Numerical illustrations show that the cost of non-cooperative fiscal policies can be large in the case of aggregate shocks, while they are small in the case of idiosyncratic shocks, provided that fiscal policy can be flexibly adjusted to cope with idiosyncratic shocks.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3232.

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    Date of creation: Feb 2002
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    Handle: RePEc:cpr:ceprdp:3232

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    Keywords: emu; policy cooperation; policy-mix; shocks;

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    1. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
    2. Roel Beetsma & Xavier Debrun & Frank Klaassen, 2001. "Is Fiscal Policy Coordination in EMU Desirable?," CESifo Working Paper Series 599, CESifo Group Munich.
    3. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June.
    4. Cooper, Richard N., 1985. "Economic interdependence and coordination of economic policies," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 23, pages 1195-1234 Elsevier.
    5. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
    6. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
    7. Dixit, Avinash & Lambertini, Luisa, 2001. "Monetary-fiscal policy interactions and commitment versus discretion in a monetary union," European Economic Review, Elsevier, vol. 45(4-6), pages 977-987, May.
    8. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Does monetary unification lead to excessive debt accumulation," Discussion Paper 1995-112, Tilburg University, Center for Economic Research.
    9. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Monetary union without fiscal coordination may discipline policymakers," Discussion Paper 1995-59, Tilburg University, Center for Economic Research.
    10. Andersen, Torben M & Spange, Morten, 2002. "International Interdependencies in Fiscal Stabilization Policies," CEPR Discussion Papers 3580, C.E.P.R. Discussion Papers.
    11. Dixit, Avinash, 2001. "Games of monetary and fiscal interactions in the EMU," European Economic Review, Elsevier, vol. 45(4-6), pages 589-613, May.
    12. Leitemo, Kai, 2004. "A game between the fiscal and the monetary authorities under inflation targeting," European Journal of Political Economy, Elsevier, vol. 20(3), pages 709-724, September.
    13. Torben Andersen, 2001. "European Integration - A Downward Bias in Employment Policies?," CESifo Working Paper Series 574, CESifo Group Munich.
    14. Dixon, Huw, 1987. "A Simple Model of Imperfect Competition with Walrasian Features," Oxford Economic Papers, Oxford University Press, vol. 39(1), pages 134-60, March.
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    Cited by:
    1. Paul R. Masson & Xavier Debrun & Catherine A. Pattillo, 2002. "Monetary Union in West Africa," IMF Working Papers 02/226, International Monetary Fund.
    2. Jochen Michaelis & Michael Pflüger, 2002. "Euroland: Besser als befürchtet, aber schlechter als erhofft?," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 71(3), pages 296-311.
    3. L. Lambertini & R. Rovelli, 2003. "Monetary and fiscal policy coordination and macroeconomic stabilization. A theoretical analysis," Working Papers 464, Dipartimento Scienze Economiche, Universita' di Bologna.
    4. repec:cbk:journl:v:2:y:2013:i:2:p:5-27 is not listed on IDEAS
    5. Damir Šehović, 2013. "General Aspects of Monetary and Fiscal Policy Coordination," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 2(3), pages 5-27.
    6. 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.
    7. Moïse Sidiropoulos & Eleftherios Spyromitros, 2006. "Fiscal Policy in a Monetary Union Under Alternative Labour-Market Structures," Working Papers of BETA 2006-25, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    8. Agnès Bénassy-Quéré, 2006. "Short-Term Fiscal Spillovers in a Monetary Union," Working Papers 2006-13, CEPII research center.

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