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Insulation impossible: fiscal spillovers in a monetary union

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  • Russell Cooper
  • Hubert Kempf
  • Dan Peled

Abstract

This paper studies the effects of monetary policy rules in a monetary union. The focus of the analysis is on the interaction between the fiscal policy of member countries (regions) and the central monetary authority. When capital markets are integrated, the fiscal policy of one country will influence equilibrium wages and interest rates. Thus there are fiscal spillovers within a federation. The magnitude and direction of these spillovers, in particular the presence of a crowding out effect, can be influenced by the choice of monetary policy rules. We find that there does not exist a monetary policy rule which completely insulates agents in one region from fiscal policy in another. Some familiar policy rules, such as pegging an interest rate, can provide partial insulation.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 30.

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Date of creation: 2009
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Handle: RePEc:fip:feddgw:30

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Keywords: Monetary policy ; Monetary unions ; Banks and banking; Central ; Fiscal policy;

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  1. Chatterjee, S. & Corbae, D., 1990. "Endogenous Market Participation and the General Equelibrium Value of Money," Working Papers, University of Iowa, Department of Economics 90-30a, University of Iowa, Department of Economics.
  2. Carlstrom, Charles T. & Fuerst, Timothy S., 1995. "Interest rate rules vs. money growth rules a welfare comparison in a cash-in-advance economy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 36(2), pages 247-267, November.
  3. Russell Cooper & Hubert Kempf & Dan Peled, 2005. "Is it is or is it ain't my obligation? Regional debt in a fiscal federation," Working Papers, Federal Reserve Bank of Dallas 0507, Federal Reserve Bank of Dallas.
  4. Scott Freeman & Joseph H. Haslag, 1996. "On the optimality of interest-bearing reserves in economies of overlapping generations (*)," Economic Theory, Springer, Springer, vol. 7(3), pages 557-565.
  5. Cooper, Russell & Kempf, Hubert & Peled, Dan, 2010. "Regional debt in monetary unions: Is it inflationary?," European Economic Review, Elsevier, Elsevier, vol. 54(3), pages 345-358, April.
  6. Kehoe, Patrick J., 1987. "Coordination of fiscal policies in a world economy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(3), pages 349-376, May.
  7. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, Springer, vol. 4(3), pages 327-44.
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Cited by:
  1. Konon, Alexander, 2012. "Direct and Indirect Crisis Effects on International Trade or: Is There a Chance to Employ an Income Stimulus to Stimulate Exports?," MPRA Paper 36363, University Library of Munich, Germany.

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