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Fiscal and Monetary Policy in a Monetary Union: Credible Inflation Targets or Monetised Debt?

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Author Info
Thomas Krichel ()
Paul Levine
Joseph Pearlman

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Abstract

The paper examines the interrelationship between fiscal and monetary policy in a two-country monetary union. The worst scenario occurs when an independent central bank (CB sets the nominal interest rate and responds to rising government debt/GDP ratios by monetisation. The result is high inflation, high debt/GDP ratios and a large public sector. Government debt and inflation are contained if the governments bear sole responsibility for solvency, but the public sector remains excessively large. The best scenario occurs if the CB removes the incentive for the governments to engineer surprise inflation by credible inflation targeting.

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File URL: http://www.econ.surrey.ac.uk/discussion_papers/RePEc/sur/surrec/surrec9403.pdf
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Publisher Info
Paper provided by Department of Economics, University of Surrey in its series Department of Economics Discussion Papers with number 9403.

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Date of creation: Mar 1994
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Handle: RePEc:sur:surrec:9403

Note: The paper was produced as part of a research programme on Economic and Monetary Union financed by the Leverhulme Trust. The authors acknowledge comments on earlier drafts of the paper made by participants at seminars or sessions given at Florida University, the RES Annual Conference 1992, the Money, Macroeconomics and Finance Study Group Annual Conference 1992 and Gdansk University. The usual disclaimer applies.
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Related research
Keywords: monetary union fiscal policy coordination monetary and fiscal policy interdependence reputation.

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
F15 - International Economics - - Trade - - - Economic Integration
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

References listed on IDEAS
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  1. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93. [Downloadable!] (restricted)
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  2. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
    Other versions:
  3. Calvo, Guillermo A & Obstfeld, Maurice, 1988. "Optimal Time-Consistent Fiscal Policy with Finite Lifetimes," Econometrica, Econometric Society, vol. 56(2), pages 411-32, March. [Downloadable!] (restricted)
  4. Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  6. Levine, Paul, 1993. "Fiscal Policy Co-ordination under EMU and the Choice of Monetary Instrument," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 61(0), pages 1-12, Suppl..
  7. Levine, Paul & Currie, David, 1987. "Does International Macroeconomic Policy Coordination Pay and Is It Sustainable?: A Two Country Analysis," Oxford Economic Papers, Oxford University Press, vol. 39(1), pages 38-74, March. [Downloadable!] (restricted)
  8. Buiter, Willem H & Patel, U, 1990. "Debt, Deficits and Inflation: An Application to the Public Finance of India," CEPR Discussion Papers 408, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
  10. Levine, Paul & Brociner, Andrew, 1994. "Fiscal policy coordination and EMU : A dynamic game approach," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 699-729. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Beetsma,Roel M.W.J. & Bovenberg,A. Lans, 1995. "The role of public debt in the game of double chicken," Research Memoranda 025, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  2. Beetsma,Roel M.W.J. & Bovenberg,A. Lans, 1995. "Monetary union without fiscal coordination may discipline policymakers," Research Memoranda 024, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
    Other versions:
  3. Beetsma, R. & Bovenberg, L., 1995. "Designing Fiscal and Monetary Institutions for a European Monetary Union," Discussion Paper 58, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  4. Beetsma, R. & Bovenberg, L., 1995. "Does monetary unification lead to excessive debt accumulation," Discussion Paper 112, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  5. Dor, Eric & Durré, Alain, 1999. "Stock Prices, Exchange Rates and Monetary Policy," Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) Discussion Paper 2000001, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES). [Downloadable!]
  6. Beetsma,Roel M.W.J., 1996. "The Interaction of Fiscal and Monetary Policy in a Monetary Union: Balancing Credibility and Flexibility," Research Memoranda 005, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
    Other versions:
  7. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Designing Fiscal and Monetary Institutions in a Second-Best World," Discussion Paper 47, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  8. Fritz Breuss & Andrea Weber, 1999. "Economic Policy Coordination in the EMU: Implications for the Stability Pact," EUI-RSCAS Working Papers 26, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS). [Downloadable!]
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