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Fiscal Policy and Macroeconomic Stability Within a Currency Union

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Author Info
Kirsanova, Tatiana
Vines, David
Wren-Lewis, Simon

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Abstract

We analyse the stability of countries within a monetary union in the face of asymmetric shocks, using a simple but widely applicable model. We show that members of the union may be subject to severe, and possibly unstable, cycles following asymmetric shocks if there is a significant backward looking element in inflation behaviour, and if real interest rates influence the level of aggregate demand. This cyclical instability can be mitigated if fiscal policy in each member country reacts to inflation differences, but it can be aggravated if fiscal feedback on debt is too strong.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5584.

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Date of creation: Mar 2006
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Handle: RePEc:cpr:ceprdp:5584

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Related research
Keywords: macroeconomic stability; monetary and fiscal policies; monetary union;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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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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  2. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages C45-61, May. [Downloadable!] (restricted)
    Other versions:
  3. Beetsma, Roel M. W. J. & Jensen, Henrik, 2004. "Mark-up fluctuations and fiscal policy stabilization in a monetary union," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 357-376, June. [Downloadable!] (restricted)
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  4. Benigno, Pierpaolo & Lopez-Salido, J. David, 2006. "Inflation Persistence and Optimal Monetary Policy in the Euro Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 587-614, April. [Downloadable!] (restricted)
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  5. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October. [Downloadable!] (restricted)
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  6. Yash P. Mehra, 2004. "The Output Gap, Expected Future Inflation and Inflation Dynamics: Another Look," The B.E. Journal of Macroeconomics, Berkeley Electronic Press, vol. 0(1). [Downloadable!]
  7. Kirsanova, Tatiana & Satchi, Mathan & Vines, David & Wren-Lewis, Simon, 2006. "Optimal Fiscal Policy Rules in a Monetary Union," CEPR Discussion Papers 5533, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. Turnovsky, Stephen J & Basar, Tamer & d'Orey, Vasco, 1988. "Dynamic Strategic Monetary Policies and Coordination in Interdependent Economies," American Economic Review, American Economic Association, vol. 78(3), pages 341-61, June.
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  9. Miller, Marcus & Sutherland, Alan, 1990. "The `Walters' Critique of the EMS: A Case of Inconsistent Expectations," CEPR Discussion Papers 480, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Bean, Charles, 1998. "The New UK Monetary Arrangements: A View from the Literature," Economic Journal, Royal Economic Society, vol. 108(451), pages 1795-1809, November. [Downloadable!] (restricted)
  11. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  12. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Blackwell Publishing, vol. 72(3), pages 707-734, 07. [Downloadable!] (restricted)
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  13. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and Fiscal Policy Interactions in a Micro-Funded Model of a Monetary Union," CEPR Discussion Papers 3591, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  14. Yash P. Mehra, 2004. "The output gap, expected future inflation and inflation dynamics: another look," Working Paper 04-06, Federal Reserve Bank of Richmond. [Downloadable!]
  15. Campbell leith & Simon Wren-Lewis, . "Compatibility Between Monetary and Fiscal Policy Under EMU," Working Papers 2001_15, Department of Economics, University of Glasgow. [Downloadable!]
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  16. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, 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.)

  1. Julian Berengaut & Katrin Elborgh-Woytek, 2006. "Beauty Queens and Wallflowers--Currency Unions in the Middle East and Central Asia," IMF Working Papers 06/226, International Monetary Fund. [Downloadable!]
  2. Oliver Landmann, 2009. "EMU@10: Coping with Rotating Slumps," Discussion Paper Series 9, Department of International Economic Policy, University of Freiburg, revised Jul 2009. [Downloadable!]
  3. Tatiana Kirsanova & David Vines & Simon Wren-Lewis, 2007. "When Inflation Persistence Really Matters: Two examples," Kiel Working Papers 1351, Kiel Institute for the World Economy. [Downloadable!]
  4. Tatiana Kirsanova & David Vines & Mathan Satchi & Simon Wren-Lewis, 2005. "Optimal Fiscal Policy Rules in a Monetary Union," Money Macro and Finance (MMF) Research Group Conference 2005 40, Money Macro and Finance Research Group. [Downloadable!]
    Other versions:
  5. Campbell Leith & Simon Wren-lewis, 2006. "Fiscal Stabilisation Policy and Fiscal Institutions," WEF Working Papers 0007, ESRC World Economy and Finance Research Programme, Birkbeck, University of London. [Downloadable!]
    Other versions:
  6. Tomasz Michalak & Jacob Engwerda & Joseph Plasmans, 2009. "Strategic Interactions between Fiscal and Monetary Authorities in a Multi-Country New-Keynesian Model of a Monetary Union," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  7. Karlygash Kuralbayeva, 2007. "Inflation persistence: Implications for a design of monetary policy in a small open economy subject to external shocks," CEIS Research Paper 93, Tor Vergata University, CEIS. [Downloadable!]
  8. Titiana Kirsanova & David Vines & Mathan Satchi & Simon Wren-Lewis, 2005. "Inflation Persistence, Fiscal Constraints and Non-cooperative Authorities Stabilization Policy in a Monetary Union," Money Macro and Finance (MMF) Research Group Conference 2005 17, Money Macro and Finance Research Group. [Downloadable!]
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