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On optimal monetary and fiscal policy interactions in open economies

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  • Chiara Forlati

Abstract

This paper studies monetary and fiscal policy interactions in a two country model, where taxes on firms’ sales are optimally chosen and the monetary policy is set cooperatively. It turns out that in a two country setting non-cooperative fiscal policy makers have an incentive to change taxes on sales depending on shocks realizations in order to reduce output production. Therefore whether the fiscal policy is set cooperatively or not matters for optimal monetary policy decisions. Indeed, as already shown in the literature, the cooperative monetary policy maker implements the flexible price allocation only when special conditions on the value of the distortions underlying the economy are met. However, if non-cooperative fiscal policy makers set the taxes on firms’ sales depending on shocks realizations, these conditions cannot be satisfied; conversely, when fiscal policy is cooperative, these conditions are fulfilled. We conclude that whether implementing the flexible price allocation is optimal or not depends on the fiscal policy regime.

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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 949.

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Date of creation: Jul 2004
Date of revision: Mar 2006
Handle: RePEc:upf:upfgen:949

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

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Keywords: Monetary and Fiscal Policy; Policy Coordination;

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  1. Correia, Maria Isabel Horta & Nicolini, Juan Pablo & Teles, Pedro, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," CEPR Discussion Papers 3730, C.E.P.R. Discussion Papers.
  2. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  3. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  4. Beetsma, Roel & Jensen, Henrik, 2002. "Monetary and fiscal policy interactions in a micro-founded model of a monetary union," Working Paper Series 0166, European Central Bank.
  5. Jordi Gali & Tommaso Monacelli, 2005. "Optimal Monetary and Fiscal Policy in a Currency Union," NBER Working Papers 11815, National Bureau of Economic Research, Inc.
  6. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
  7. Jordi Galí & Tommaso Monacelli, 2005. "Optimal Monetary and Fiscal Policy in a Currency Union," Working Papers 240, Barcelona Graduate School of Economics.
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