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Fiscal Policy and Macroeconomic Stability Within a Currency Union

  • Kirsanova, Tatiana
  • Vines, David
  • Wren-Lewis, Simon

We analyse the stability of countries within a monetary union in the face of asymmetric shocks, using a simple but widely applicable model. We show that members of the union may be subject to severe, and possibly unstable, cycles following asymmetric shocks if there is a significant backward looking element in inflation behaviour, and if real interest rates influence the level of aggregate demand. This cyclical instability can be mitigated if fiscal policy in each member country reacts to inflation differences, but it can be aggravated if fiscal feedback on debt is too strong.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5584.

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Date of creation: Mar 2006
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Handle: RePEc:cpr:ceprdp:5584
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