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Overturning Mundell: Fiscal Policy in a Monetary Union

  • Russell Cooper
  • Hubert Kempf

Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell (1961) : a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks. Copyright 2004, Wiley-Blackwell.

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Article provided by Oxford University Press in its journal The Review of Economic Studies.

Volume (Year): 71 (2004)
Issue (Month): 2 ()
Pages: 371-396

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Handle: RePEc:oup:restud:v:71:y:2004:i:2:p:371-396
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