Motivated by the accession of new member states into the European Union, this paper examines the appeal of taking part in a large monetary union from the perspective of small open economies. Consistent with existing findings in the literature, we show that in the absence of fiscal policy considerations, taking part in a large monetary union is counterproductive for a small economy. Nevertheless, once the role of fiscal policy is properly incorporated, taking part in the monetary union becomes desirable from a social perspective. Following these results, we explore the prospects of engaging both economies in fiscal coordination and on how different schemes of policy synchronization can provide the grounds to make cooperation beneficial for the members of a monetary union. We find that when monetary and fiscal authorities cooperate and attempt to exploit externalities for their own benefit, a Pareto efficient outcome can be achieved if fiscal policy in the monetary union is coordinated by a central authority and such authority acts as a Stackelberg leader vis-à-vis the central bank. Our analysis suggests that this regime result superior to (i) a monetary union in which fiscal authorities conduct their policy in an independent or (ii) coordinated fashion, (iii) to a regime where both authorities internalize the effects of their own externalities by allowing the central bank to act as Stackelberg leader and (iv) event to a regime in which the small open economy decides to stay out of the monetary union.
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Paper provided by Department of Economics, University of York in its series Discussion Papers with number
05/28.
Length: Date of creation: Date of revision: Handle: RePEc:yor:yorken:05/28
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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 E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination F15 - International Economics - - Trade - - - Economic Integration
References listed on IDEAS 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.:
Rafael Domenech & Javier Andres & Antonio Fatas, 2006.
"The Stabilizing Role of Government Size,"
Working Papers
0603, International Economics Institute, University of Valencia, revised Jan 2007.
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