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Fiscal and Monetary Policy Coordination in EMU

  • Jürgen von Hagen
  • Susanne Mundschenk

The purpose of this paper is to analyze and discuss the coordination of fiscal and monetary policies in EMU. In section 2, we develop a framework for studying monetary and fiscal policy in a monetary union to explore the implications of the common currency for policy coordination. We show that there is little need for coordinating monetary and fiscal policies in the long run. In section 3, we study the interaction of monetary and fiscal policies in the short run. A monetary policy firmly committed to price stability at the EMU level implies that the central bank controls aggregate output at the euro-area level, while national fiscal policies determine the distribution of aggregate demand across the participating countries. Thus, national governments are engaged in a purely distributional game with inefficient outcomes unless policies are coordinated. If monetary policy also pursues a goal of output stabilization, policy coordination should include the central bank together with the fiscal authorities. We also show that the proposal to restrict fiscal policies to the operation automatic stabilizers at the national level, which is now often made in EMU, does not solve the issue of policy coordination. Instead, it worsens the situation of the central bank unless automatic stabilizers are identical in all member economies. In section 4, we review the existing mechanisms for policy coordination and show that they are deficient, since they focus on the long run rather than the short run and largely ignore the interdependence of national economic policies and the ECB’s monetary policy. Section 5 concludes.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 194.

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Date of creation: Dec 2002
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Handle: RePEc:chb:bcchwp:194
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  1. Beetsma, Roel M W J & Bovenberg, A Lans, 2000. " Designing Fiscal and Monetary Institutions for a European Monetary Union," Public Choice, Springer, vol. 102(3-4), pages 247-69, March.
  2. Dixit, Avinash & Lambertini, Luisa, 2003. "Symbiosis of monetary and fiscal policies in a monetary union," Journal of International Economics, Elsevier, vol. 60(2), pages 235-247, August.
  3. Patrick, John D., 1973. "Establishing convergent decentralized policy assignment," Journal of International Economics, Elsevier, vol. 3(1), pages 37-51, February.
  4. Sibert, Anne & Sutherland, Alan, 2000. "Monetary union and labor market reform," Journal of International Economics, Elsevier, vol. 51(2), pages 421-435, August.
  5. Uhlig, Harald, 2002. "One Money, but Many Fiscal Policies in Europe: What Are the Consequences?," CEPR Discussion Papers 3296, C.E.P.R. Discussion Papers.
  6. Dixit, Avinash & Lambertini, Luisa, 2001. "Monetary-fiscal policy interactions and commitment versus discretion in a monetary union," European Economic Review, Elsevier, vol. 45(4-6), pages 977-987, May.
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