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Optimal Monetary and Fiscal Policy in a Currency Union

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Author Info
Tommaso Monacelli
Jordi Galí

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Abstract

We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the efficient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper offers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 300.

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Date of creation: 2005
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Handle: RePEc:igi:igierp:300

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  8. Andrea Ferrero, 2005. "Fiscal and Monetary Rules for a Currency Union," Macroeconomics 0508020, EconWPA. [Downloadable!]
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  13. 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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  1. Ludger Linnemann & Andreas Schabert, 2008. "Optimal Government Spending and Unemployment," Tinbergen Institute Discussion Papers 08-024/2, Tinbergen Institute. [Downloadable!]
  2. Canale, R.R., 2008. "Central bank reaction to public deficit and sound public finance: the case of the European Monetary Union," MPRA Paper 8789, University Library of Munich, Germany. [Downloadable!]
  3. Chiara Forlati, 2004. "On Optimal Monetary and Fiscal Policy Interactions in Open Economies," Economics Working Papers 949, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2006. [Downloadable!]
  4. Michael Kumhof & Douglas Laxton, 2009. "Simple, Implementable Fiscal Policy Rules," IMF Working Papers 09/76, International Monetary Fund. [Downloadable!]
  5. Mirko Abbritti; Sebastian Weber, 2008. "Labor Market Rigidities and the Business Cycle: Price vs. Quantity Restricting Institutions," HEI Working Papers 01-2008, Economics Section, The Graduate Institute of International Studies, revised Jan 2008. [Downloadable!]
  6. Klaus Adam & Roberto M. Billi, 2007. "Monetary conservatism and fiscal policy," Research Working Paper RWP 07-01, Federal Reserve Bank of Kansas City. [Downloadable!]
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  7. Paolo Zagaglia, 2007. "Operational Fiscal and Monetary Policy with Staggered Wage and Price Dynamics," Finnish Economic Papers, Finnish Economic Association, vol. 20(2), pages 121-138, Autumn. [Downloadable!]
  8. Marcelo Sánchez, 2008. "Monetary stabilisation in a currency union of small open economies," Working Paper Series 927, European Central Bank. [Downloadable!]
  9. Oliver Grimm & Stefan Ried, 2007. "Macroeconomic Policy in a Heterogeneous Monetary Union," SFB 649 Discussion Papers SFB649DP2007-028, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
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  10. Claeys Peter, 2008. "Estimating the effects of fiscal policy under the budget constraint," wp.comunite 0038, Department of Communication, University of Teramo. [Downloadable!]
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  11. S. Gnocchi, 2007. "Discretionary Fiscal Policy and Optimal Monetary Policy in a Currency Area ," Working Papers 602, Dipartimento Scienze Economiche, Universita' di Bologna. [Downloadable!]
  12. Herings P. Jean-Jacques & Peeters Ronald & Yang Michael S., 2009. "Piracy on the internet: Accommodate it or fight it? A dynamic approach," Research Memoranda 034, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  13. Ricardo M. Sousa & António Afonso, 2008. "The Macroeconomic Effects of Fiscal Policy," NIPE Working Papers 22/2008, NIPE - Universidade do Minho. [Downloadable!]
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  14. Bernhard Herz & Werner Roeger & Lukas Vogel, . "Optimal Simple Rules for Fiscal Policy in a Monetary Union," Macroeconomics, Department of Economics, Economics I, Bayreuth University. [Downloadable!]
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  15. Fabian Eser & Campbell Leith & Simon Wren-Lewis, 2009. "When is monetary policy all we need?," Working Papers 2009_18, Department of Economics, University of Glasgow. [Downloadable!]
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  16. Stéphane Auray & Aurélien Eyquem & Jean-Christophe Poutineau, 2008. "The Welfare Gains of Trade Integration in the European Monetary Union," Cahiers de recherche 08-10, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke. [Downloadable!]
  17. Mirko Abbritti, 2007. "A "Simple" Currency Union Model with Labor Market Frictions, Real Wage Rigidities and Equilibrium Unemployment," HEI Working Papers 09-2007, Economics Section, The Graduate Institute of International Studies. [Downloadable!]
  18. Canale, Rosaria Rita, 2006. "Positive effects of fiscal expansions on growth and debt," MPRA Paper 1432, University Library of Munich, Germany, revised Nov 2006. [Downloadable!]
  19. 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. [Downloadable!]
  20. Adao, Bernardino & Correia, Maria Isabel Horta & Teles, Pedro, 2006. "On the Relevance of Exchange Rate Regimes for Stabilization Policy," CEPR Discussion Papers 5797, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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