IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Macroeconomic Tradeoffs in the United States and Europe: Fiscal Distortions and the International Monetary Regime

  • Barry Eichengreen

    (University of California, Berkeley)

  • Fabio Ghironi


    (Boston College)

This paper studies the impact of changes in the extent to which fiscal policy is distortionary on the short-run macroeconomic tradeoffs facing fiscal policymakers in an era of budget equilibrium. It does so in an open economy framework, that we use to interpret U.S.-European policy interactions. Our analysis features both fiscal and monetary policy to study how changes in the extent to which fiscal policy is distortionary affect the interaction between central banks and fiscal authorities, both intra- and internationally. In addition, strategic interactions among policymakers≥and the tradeoffs they face≥are affected by the exchange-rate regime. When government spending is funded through distortionary taxes alone≥a scenario that we call anti-Keynesian, changing spending moves both inflation and employment in the desired direction following a worldwide supply shock. Smaller and more open economies face a more favorable tradeoff than large relatively closed ones. Under a managed exchange rate regime, European governments face a better tradeoff than under flexible rates, but the improvement is more significant for the country that controls the exchange rate. When both European countries in our model join in a monetary union, the country that had control of the exchange rate under the managed exchange rate regime faces a worse tradeoff, while the tradeoff improves for the country that controlled money supply. In the fully Keynesian case, in which taxes are non-distortionary, all countries face the same positively sloped tradeoff regardless of the exchange-rate regime. Increases in spending cause both output and inflation to rise. When fiscal policy is neither fully anti-Keynesian nor fully Keynesian, the governments' tradeoffs lie in between the extreme cases, and the exact position depends on the extent to which fiscal policy is Keynesian. Under all European exchange-rate regimes, small increases in the fraction of firms that are subject to distortionary taxation at home are beneficial when the equilibrium is characterized by unemployment, while a less Keynesian fiscal policy abroad is harmful. Governments in the U.S. and Europe will want the ECB and the Fed to coordinate their reactions to an unfavorable supply shock, while monetary policymakers will have little incentive to do so. Intra-European fiscal cooperation can be counterproductive, whereas cooperation between governments and central banks inside each continent can be beneficial. Our study suggests that, if governments are concerned mainly about the relation between fiscal policy and the business cycle, maintaining some fiscal distortions may be optimal.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
File Function: main text
Download Restriction: no

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 467.

in new window

Length: 54 pages
Date of creation: 22 Nov 1999
Date of revision:
Handle: RePEc:boc:bocoec:467
Contact details of provider: Postal: Boston College, 140 Commonwealth Avenue, Chestnut Hill MA 02467 USA
Phone: 617-552-3670
Fax: +1-617-552-2308
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Beetsma, Roel M. W. J. & Lans Bovenberg, A., 1998. "Monetary union without fiscal coordination may discipline policymakers," Journal of International Economics, Elsevier, vol. 45(2), pages 239-258, August.
  2. Alberto Alesina & Silvia Ardagna & Roberto Perotti & Fabio Schiantarelli, 2002. "Fiscal Policy, Profits, and Investment," American Economic Review, American Economic Association, vol. 92(3), pages 571-589, June.
  3. Giavazzi, Francesco & Pagano, Marco, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," CEPR Discussion Papers 417, C.E.P.R. Discussion Papers.
  4. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  5. Chari, V.V. & Kehoe, Patrick J., 2007. "On the need for fiscal constraints in a monetary union," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2399-2408, November.
  6. Ghironi, Fabio & Giavazzi, Francesco, 1998. "Currency areas, international monetary regimes, and the employment-inflation tradeoff," Journal of International Economics, Elsevier, vol. 45(2), pages 259-296, August.
  7. Giavazzi, Francesco & Pagano, Marco, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," CEPR Discussion Papers 1284, C.E.P.R. Discussion Papers.
  8. D. Begg & F. Giavazzi & Ch. Wyplosz, 1999. "Options for the Future Exchange RatePolicy of the EMU," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 1.
  9. Ardagna, Silvia & Alesina, Alberto, 1998. "Tales of Fiscal Adjustment," Scholarly Articles 2579822, Harvard University Department of Economics.
  10. Eichengreen, Barry & Ghironi, Fabio, 1997. "How Will Transatlantic Policy Interactions Change with the Advent of EMU?," CEPR Discussion Papers 1643, C.E.P.R. Discussion Papers.
  11. Alberto Alesina & Silvia Ardagna, 1998. "Tales of fiscal adjustment," Economic Policy, CEPR;CES;MSH, vol. 13(27), pages 487-545, October.
  12. Matthew B. Canzoneri & Dale W. Henderson, 1991. "Monetary Policy in Interdependent Economies: A Game-Theoretic Approach," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031787, June.
  13. Gilles Saint Paul, 1998. "The political consequences of unemployment," Economics Working Papers 343, Department of Economics and Business, Universitat Pompeu Fabra.
  14. Artis, Michael J & Gazioglu, Saziye, 1987. "A Two-Country Model with Asymmetric Phillips Curves and Intervention in the Foreign Exchange Market," CEPR Discussion Papers 172, C.E.P.R. Discussion Papers.
  15. Fabio Ghironi, 2000. "U.S.-Europe Economic Interdependence and Policy Transmission," Boston College Working Papers in Economics 470, Boston College Department of Economics.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:boc:bocoec:467. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.