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Optimal monetary and fiscal policy in a currency union

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  • Jordi Galí

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  • Tommaso Monacelli

Abstract

We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and study 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. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal cooperative policy arrangement requires that inflation be stabilized at the union level by the common central bank, while fiscal policy is used by each country for stabilization purposes. By contrast, when the fiscal authorities act in a non-coordinated way, their joint actions lead to a suboptimal outcome, and make the common central bank face a trade-off between inflation and output gap stabilization at the union level.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 909.

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Date of creation: Oct 2005
Date of revision: Feb 2008
Handle: RePEc:upf:upfgen:909

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Web page: http://www.econ.upf.edu/

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Keywords: Monetary union; sticky prices; countercyclical policy; inflation differentials;

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  1. Annoying Anti-Stimulus Arguments: Numbers 1 and 2
    by Mainly Macro in Mainly Macro on 2012-01-29 21:26:00
  2. Why anti-stimulus arguments do not apply
    by Lars P Syll in Lars P Syll's Blog on 2012-01-30 09:36:54
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