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Mark-up fluctuations and fiscal policy stabilization in a monetary union

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  • Beetsma, Roel M. W. J.
  • Jensen, Henrik

Abstract

We study optimal monetary and fiscal stabilization policy in a two-country monetary union in the presence of (inefficient) mark-up shocks, price rigidities and monopolistic competition. The underlying dynamic system contains two Phillips curves featuring public spending and mark-up shocks. We derive the second-order welfare loss approximation and characterize optimal monetary and fiscal policies under commitment and discretion. With symmetric rigidities, fiscal policy will not be employed in stabilizing union-level variables. Relative spending levels, however, are used to stabilize relative inflation rates and the terms of trade. Under commitment, both monetary policy and relative spending are inertial, while this is not the case under discretion. We conduct numerical analyses to assess the welfare gains from commitment and from having resource to fiscal stabilization. These gains are substantial. We conclude by investigating some simple monetary and fiscal policy rules. The former are based on the standard Taylor rule, while the fiscal rules link spending to output gaps. With mark-up shocks, the optimal fiscal rules are pro-cyclical. Finally, we find that welfare gains are obtained by making the rules inertial.
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Suggested Citation

  • Beetsma, Roel M. W. J. & Jensen, Henrik, 2004. "Mark-up fluctuations and fiscal policy stabilization in a monetary union," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 357-376, June.
  • Handle: RePEc:eee:jmacro:v:26:y:2004:i:2:p:357-376
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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