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Strategic Interactions between Monetary and fiscal Policies : a case study for the European Stability Pact

  • Creel, Jérôme

We extend the model of Leith and Wren-Lewis (2000) to the case of a monetary union. Within a two-country dynamic model with wealth private behaviours, we study the implications of stabilising public debt on monetary and fiscal policies. The model is a macroeconomic version of the Fiscal Theory of the Price Level. We introduce an asymmetry in fiscal policies: one fiscal policy is ‘active’ in the short run; the other is always ‘passive’. Both policies are the outcomes of a game between the two governments and the ECB. In this framework, we assess the ‘beggar-thy-neighbour’ consequences of the passive fiscal policy in the fiscally-constrained country. Because of the inability of this government to implement an ‘active’ policy, the other government may incur a higher public debt burden. The ECB has to get more involved in the macroeconomic stabilisation process and has to prevent fiscal policy in the country with sound public finance from being too much active. The more substantial these ‘beggar-thy-neighbour’ effects, the more profitable cooperation between governments and the central bank.

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Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/3413.

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Date of creation: Jun 2001
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Handle: RePEc:dau:papers:123456789/3413
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  1. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  2. Jérôme Creel & Henri Sterdyniak, 2002. "The fiscal theory of the price level and sluggish inflation: how important shall the wealth effect be?," Sciences Po publications 2002-01, Sciences Po.
  3. Fabrice Capoën & Pierre Villa, 1997. "Internal and External Policy Coordination: a Dynamic Analysis," Working Papers 1997-15, CEPII research center.
  4. Barrell, Ray & Sefton, James, 1997. "Fiscal Policy and the Masstricht Solvency Criteria," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(3), pages 259-79, June.
  5. Willem H. Buiter, 2001. "The fallacy of the fiscal theory of the price level, again," Bank of England working papers 141, Bank of England.
  6. Jensen, Svend Erik Hougaard & Jensen, Lars Grue, 1995. "Debt, deficits and transition to EMU: A small country analysis," European Journal of Political Economy, Elsevier, vol. 11(1), pages 3-25, March.
  7. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  8. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  9. Bergin, Paul R., 2000. "Fiscal solvency and price level determination in a monetary union," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 37-53, February.
  10. Jeffrey C. Fuhrer, 1995. "The [un]importance of forward-looking behavior in price specifications," Working Papers 95-6, Federal Reserve Bank of Boston.
  11. Creel, Jérôme, 2002. "The European Stability Pact and Feedback Policy Effects," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 17, pages 570-595.
  12. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  13. Blake, Andrew P & Weale, Martin, 1998. "Costs of Separating Budgetary Policy from Control of Inflation: A Neglected Aspect of Central Bank Independence," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 449-67, July.
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