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The unbearable tightness of being in a monetary union : fiscal restrictions and regional stability

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  • Evi Pappa

Abstract

We study how constrained fiscal policy can affect regional inflation and output in a two-region model of a monetary union with sticky prices and distortionary taxation. Both government expenditure and taxes can be used to stabilize regional variables; however, the best welfare outcome is obtained under constant taxes and constant regional inflations. With cooperation debt and deficit constraints reduce regional inflation variability, but the path of output is suboptimal. Under non-cooperation the opposite occurs due to a trade-off between taxation and inflation variability. Decentralized rules, rather than constraints, stabilize regional inflation and output. They imply more fiscal action for smaller union members.

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File URL: http://eprints.lse.ac.uk/510/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 510.

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Length: 26 pages
Date of creation: Dec 2004
Date of revision:
Handle: RePEc:ehl:lserod:510

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Keywords: Inflation differentials; monetary union; budgetary restrictions; fiscal rules. JEL classification codes : E63; F41; F42;

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Citations

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Cited by:
  1. Stéphane Auray & Aurélien Eyquem, 2012. "Welfare Reversal in Monetary Union," Working Papers, Centre de Recherche en Economie et Statistique 2012-33, Centre de Recherche en Economie et Statistique.
  2. Jes?s Crespo-Cuaresma & Octavio Fern?ndez-Amador, 2010. "Business cycle convergence in EMU: A first look at the second moment," Working Papers 2010-22, Faculty of Economics and Statistics, University of Innsbruck.
  3. Evers, Michael P., 2012. "Federal fiscal transfer rules in monetary unions," European Economic Review, Elsevier, vol. 56(3), pages 507-525.
  4. Stéphane Auray & Beatriz De Blaz & Aurélien Eyquem, 2011. "Ramsey Policies in a Small Open Economy with Sticky Prices and Capital," Post-Print halshs-00581173, HAL.
  5. Lipinska, Anna, 2008. "The Maastricht Criteria and Optimal Monetary and Fiscal Policy Mix for the EMU Accession Countries," MPRA Paper 16376, University Library of Munich, Germany.
  6. Thushyanthan Baskaran & Zohal Hessami, 2011. "A Tale of Five PIIGS: Soft Budget Constraints and the EMU Sovereign Debt Crises," Working Paper Series of the Department of Economics, University of Konstanz 2011-45, Department of Economics, University of Konstanz.
  7. Juan Carlos Hatchondo & Francisco Roch & Leonardo Martinez, 2012. "Fiscal Rules and the Sovereign Default Premium," IMF Working Papers 12/30, International Monetary Fund.
  8. Roel Beetsma & Massimo Giuliodori, 2010. "The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: An Overview of Recent Research," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 603-41, September.
  9. Muhammad Ali Nasir & Alaa M. Soliman, 2014. "Aspects of Macroeconomic Policy Combinations and Their Effects on Financial Markets," Economic Issues Journal Articles, Economic Issues, Economic Issues, vol. 19(1), pages 95-118, March.
  10. Yasuharu Iwata, 2011. "The Government Spending Multiplier and Fiscal Financing: Insights from Japan," International Finance, Wiley Blackwell, vol. 14(2), pages 231-264, 06.
  11. Mykhaylova, Olena, 2009. "Welfare implications of country size in a monetary union," MPRA Paper 23323, University Library of Munich, Germany.
  12. Matthew Canzoneri, 2007. "Coordination of Monetary and Fiscal Policy in a Monetary Union: Policy Issues & Analytical Models," Money Macro and Finance (MMF) Research Group Conference 2006, Money Macro and Finance Research Group 165, Money Macro and Finance Research Group.
  13. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo Group Munich.
  14. Beetsma, Roel & Ribeiro, Marcos Poplawski & Schabert, Andreas, 2008. "A Comparison of Debt and Primary-deficit Constraints," CEPR Discussion Papers 6897, C.E.P.R. Discussion Papers.
  15. Stéphane Auray & Aurélien Eyquem & Gérard Hamiache & Jean-Christophe Poutineau, 2008. "Sharing Money Creation in a Monetary Union," Review of International Economics, Wiley Blackwell, vol. 16(5), pages 817-834, November.
  16. Steffen Elstner & Nikolay Hristov & Oliver Hülsewig & Timo Wollmershäuser, 2010. "Optimal Monetary Policy in a Monetary Union with Housing and Credit Market Heterogeneity," Working Paper / FINESS, DIW Berlin, German Institute for Economic Research 7.4B, DIW Berlin, German Institute for Economic Research.
  17. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2012. "On the optimal mix of fiscal and monetary policy actions," Working Papers 150, Bank of Greece.
  18. repec:diw:diwfin:diwfin07042 is not listed on IDEAS

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