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Optimal Fiscal Substitutes For The Exchange Rate In A Monetary Union

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  • Kaufmann, Christoph

Abstract

This paper studies Ramsey-optimal monetary and fiscal policy in a New Keynesian 2-country open economy framework, which is used to assess how far fiscal policy can substitute for the role of nominal exchange rates within a monetary union. Giving up exchange rate flexibility can result in high welfare costs, which depend significantly on whether firms set prices in producer or in local currency. By using only one tax instrument per country and robust to changes in the calibration, the welfare costs can be reduced by 86% in case of producer currency pricing and by 68% in case of local currency pricing. Optimal policy in a monetary union can be described as a fiscal devaluation: if a nominal devaluation of the domestic currency is optimal under flexible exchange rates, optimal fiscal policy in a monetary union is a relative increase of the domestic VAT.

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  • Kaufmann, Christoph, 2016. "Optimal Fiscal Substitutes For The Exchange Rate In A Monetary Union," VfS Annual Conference 2016 (Augsburg): Demographic Change 145873, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc16:145873
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    6. Hinterlang, Natascha & Martin, Anika & Röhe, Oke & Stähler, Nikolai & Strobel, Johannes, 2021. "Using energy and emissions taxation to finance labor tax reductions in a multi-sector economy: An assessment with EMuSe," Discussion Papers 50/2021, Deutsche Bundesbank.
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    More about this item

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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