Taking Real Rigidities Seriously: Implications for Optimal Policy Design in a Currency Union
AbstractIn this paper I analyze optimal monetary and fiscal policy in a monetary union from a union-wide perspective. For this purpose I lay out a New Keynesian business cycle model of a currency union with rigid real wages. The fiscal policy is implemented at the country level through the choice of government spending, while the monetary authority sets a common nominal interest rate. I find that, given these assumptions, in the presence of country-specific as well as in the presence of symmetric shocks to technology there is a country-level trade-off between stabilizing inflation and output relative to its efficient outcome. After a union-wide technology shock also the common monetary authority faces a trade-off. Hence, if the shift to technology is common to all member countries the optimal policy on a union-wide level requires that the common monetary policy reacts slightly countercyclical. This is reversed on the domestic level, where, under the optimal policy, the government purchases stabilize the economy via countercyclical spending, no matter if shocks are symmetric or not. Although not always optimal, I find that strict inflation targeting is very close to the optimal policy in terms of aggregate welfare losses.
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Bibliographic InfoPaper provided by Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization in its series Research Memoranda with number 032.
Date of creation: 2009
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Web page: http://www.maastrichtuniversity.nl/web/UMPublications.htm
monetary economics ;
Other versions of this item:
- Lieb Lenard, 2009. "Taking Real Rigidities Seriously: Implications for Optimal Policy Design in a Currency Union," Research Memorandum 032, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
- NEP-ALL-2009-07-28 (All new papers)
- NEP-GTH-2009-07-28 (Game Theory)
- NEP-UPT-2009-07-28 (Utility Models & Prospect Theory)
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.:
- Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
- J. A. Carrillo, 2011.
"How Well Does Sticky Information Explain the Dynamics of Inflation, Output, and Real Wages?,"
Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium
11/724, Ghent University, Faculty of Economics and Business Administration.
- Carrillo, Julio A., 2012. "How well does sticky information explain the dynamics of inflation, output, and real wages?," Journal of Economic Dynamics and Control, Elsevier, vol. 36(6), pages 830-850.
- Carrillo Julio A., 2010. "How Well Does Sticky Information Explain Inflation and Output Inertia?," Research Memoranda 018, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization.
- Carrillo, Julio A., 2009. "Sticky information vs. Backward-looking indexation: Inflation inertia in the U.S," Research Memoranda 008, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization.
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