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Fiscal Policy and Macroeconomic Stability Within a Currency Union

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  • Kirsanova, Tatiana
  • Vines, David
  • Wren-Lewis, Simon

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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Bibliographic Info

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

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References

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  1. 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.
  2. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
  3. 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.
  4. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Beetsma, Roel & Jensen, Henrik, 2003. "Mark-Up Fluctuations and Fiscal Policy Stabilization in a Monetary Union," CEPR Discussion Papers 4020, C.E.P.R. Discussion Papers.
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  8. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  9. Leith, Campbell & Simon Wren-Lewis, 2002. "Compatibility Between Monetary and Fiscal Policy Under EMU," Royal Economic Society Annual Conference 2002 124, Royal Economic Society.
  10. 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.
  11. Yash P. Mehra, 2004. "The output gap, expected future inflation and inflation dynamics: another look," Working Paper 04-06, Federal Reserve Bank of Richmond.
  12. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  13. Pierpaolo Benigno & J. David López-Salido, 2002. "Inflation persistence and optimal monetary policy in the Euro Area," Banco de Espa�a Working Papers 0215, Banco de Espa�a.
  14. 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.
  15. Mehra Yash P, 2004. "The Output Gap, Expected Future Inflation and Inflation Dynamics: Another Look," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-19, December.
  16. Gray, Malcolm R & Turnovsky, Stephen J, 1979. "Expectational Consistency, Informational Lags, and the Formulation of Expectations in Continuous Time Models," Econometrica, Econometric Society, vol. 47(6), pages 1457-74, November.
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Citations

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Cited by:
  1. 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.
  2. 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 2534, CESifo Group Munich.
  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.
  4. Alan Ahearne & Juan Delgado & Jakob von Weizsäcker, 2008. "A tail of two countries," Policy Briefs 6, Bruegel.
  5. Katrin Elborgh-Woytek & Julian Berengaut, 2006. "Beauty Queens and Wallflowers," IMF Working Papers 06/226, International Monetary Fund.
  6. Tatiana Kirsanova & Mathan Satchi & David Vines & Simon Wren-Lewis, 2006. "Optimal Fiscal Policy Rules in a Monetary Union," Discussion Papers 0611, Exeter University, Department of Economics.
  7. Oliver Landmann, 2012. "Rotating Slumps in a Monetary Union," Open Economies Review, Springer, vol. 23(2), pages 303-317, April.
  8. 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.
  9. Oliver Landmann, 2009. "EMU@10: Coping with Rotating Slumps," Discussion Paper Series 9, Department of International Economic Policy, University of Freiburg, revised Jul 2009.
  10. 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.

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