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Optimal Monetary and Fiscal Policy in a Currency Union

  • Jordi Galí
  • Tommaso Monacelli
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    We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the efficient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper oers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.

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    File URL: http://research.barcelonagse.eu/tmp/working_papers/240.pdf
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    Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 240.

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    Date of creation: Oct 2005
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    Handle: RePEc:bge:wpaper:240
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    1. Ferrero, Andrea, 2005. "Fiscal and monetary rules for a currency union," Working Paper Series 0502, European Central Bank.
    2. Lombardo, Giovanni & Sutherland, Alan, 2003. "Monetary and fiscal interactions in open economies," Working Paper Series 0289, European Central Bank.
    3. Brulhart, Marius & Trionfetti, Federico, 2004. "Public expenditure, international specialisation and agglomeration," European Economic Review, Elsevier, vol. 48(4), pages 851-881, August.
    4. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
    5. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
    6. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers C99-107, University of California at Berkeley.
    7. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
    8. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
    9. Federico Trionfetti, 2000. "Discriminatory Public Procurement and International Trade," The World Economy, Wiley Blackwell, vol. 23(1), pages 57-76, 01.
    10. Robert Kollmann, 2001. "The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation," ULB Institutional Repository 2013/7630, ULB -- Universite Libre de Bruxelles.
    11. Linnemann, Ludger & Schabert, Andreas, 2003. " Fiscal Policy in the New Neoclassical Synthesis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(6), pages 911-29, December.
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