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The Interaction of Fiscal and Monetary Policy in a Monetary Union: Balancing Credibility and Flexibility

  • Beetsma, R.M.W.J.
  • Bovenberg, A.L.

This paper explores how decentralized, national fiscal policies interact with a common monetary policy in a monetary union. We show that fiscal policy plays a more important role in stabilizing country-specific shocks than with national monetary policies. Whereas monetary unification with an optimally designed central bank reduces both expected inflation and the variance of inflation, it harms overall welfare by reducing output and public spending and increasing the variability of these variables. However, international transfers may avoid this decline in welfare. Keywords: monetary union, stabilization, central bank conservatism, credibility, flexibility. JEL codes: E52, E58, E61, E62. November 1995 Mailing address: LIFE/Department of Economics University of Limburg P.O.Box 616 6200 MD Maastricht The Netherlands * Part of this paper was written while Beetsma was a postdoctoral fellow at DELTA (Joint Research Unit CNRS-EHESS-ENS). He thanks DELTA for the stimulating research environment.

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Paper provided by DELTA (Ecole normale supérieure) in its series DELTA Working Papers with number 95-24.

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Length: 29 pages
Date of creation: 1995
Date of revision:
Publication status: Published in Razin, A. and E. Sadka (eds.), The Economics of Globalization: Policy Perspectives from Public Economics, Cambridge University Press
Handle: RePEc:del:abcdef:95-24
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  1. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
  2. Laskar Daniel, 1987. "Conservative central bankers in a two-country world," CEPREMAP Working Papers (Couverture Orange) 8705, CEPREMAP.
  3. Jay Bryson, 1994. "Macroeconomic stabilization through monetary and fiscal policy coordination: Implications for European Monetary Union," Open Economies Review, Springer, vol. 5(4), pages 307-326, October.
  4. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Designing fiscal and monetary institutions in a second-best world," Discussion Paper 1995-47, Tilburg University, Center for Economic Research.
  5. Eijffinger, S.C.W. & Schaling, E., 1995. "The ultimate determinants of central bank independence," Discussion Paper 1995-5, Tilburg University, Center for Economic Research.
  6. Beetsma, R.M.W.J. & Bovenberg, A.L., 1995. "Does monetary unification lead to excessive debt accumulation," Discussion Paper 1995-112, Tilburg University, Center for Economic Research.
  7. Levine, Paul, 1993. "Fiscal Policy Co-ordination under EMU and the Choice of Monetary Instrument," The Manchester School of Economic & Social Studies, University of Manchester, vol. 61(0), pages 1-12, Suppl..
  8. Cukierman Alex, 1992. "Central Bank Strategy, Credibility, And Independance: Theory And Evidence," Journal des Economistes et des Etudes Humaines, De Gruyter, vol. 3(4), pages 10, December.
  9. Xavier Sala-i-Martin & Jeffrey Sachs, 1991. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States," NBER Working Papers 3855, National Bureau of Economic Research, Inc.
  10. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  11. Levine, Paul L & Pearlman, Joseph, 1992. "Fiscal and Monetary Policy Under EMU: Credible Inflation Targets or Unpleasant Monetary Arithmetic?," CEPR Discussion Papers 701, C.E.P.R. Discussion Papers.
  12. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  13. Alesina, Alberto & Tabellini, Guido, 1987. "Rules and Discretion with Noncoordinated Monetary and Fiscal Policies," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 619-30, October.
  14. Calvo, Guillermo A & Guidotti, Pablo E, 1993. "On the Flexibility of Monetary Policy: The Case of the Optimal Inflation Tax," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 667-87, July.
  15. von Hagen, Jurgen & Suppel, Ralph, 1994. "Central bank constitutions for federal monetary unions," European Economic Review, Elsevier, vol. 38(3-4), pages 774-782, April.
  16. Padilla, Atilano Jorge, 1995. "Designing Institutions for International Monetary Policy Coordination," CEPR Discussion Papers 1180, C.E.P.R. Discussion Papers.
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