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Efficient Fiscal Policy Restrictions in a Monetary Union

In: International Trade and Economic Dynamics

Author

Listed:
  • Azariadis Costas

    (Washington University in St. Louis, and Federal Reserve Bank of St. Louis)

  • Raphael W. K. Lam

    (Washington University in St. Louis, and Federal Reserve Bank of St. Louis)

Abstract

We study the interactions of monetary and fiscal policies in the context of a monetary union. Tensions over fiscal policies have become one of the key issues in the operation in the European Union. We analyze restrictions on public debt in a monetary union in which a patient central bank plays a one-shot Stackel-berg game against a number of impatient fiscal authorities in a simple environment without uncertainty. The noncooperative outcome of this game is excessive borrowing relative to the planning optimum. This will drive up the inflation target as the central bank attempts to minimize the impact of higher yields on borrowing member nations. Fiscal borrowing constraints on member nations improve economic coordination by bringing public deficits more in line with household desires, in turn reducing the pressure on the central bank to inflate its way to lower real yields. We show, in particular, that there exist fiscal constraints supporting the cooperative allocation as a Stackelberg equilibrium.

Suggested Citation

  • Azariadis Costas & Raphael W. K. Lam, 2009. "Efficient Fiscal Policy Restrictions in a Monetary Union," Springer Books, in: Takashi Kamihigashi & Laixun Zhao (ed.), International Trade and Economic Dynamics, pages 345-360, Springer.
    • Handle: RePEc:spr:sprchp:978-3-540-78676-4_24
    DOI: 10.1007/978-3-540-78676-4_24
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