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Overturning Mundell: fiscal policy in a monetary union

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  • Russell W. Cooper
  • Hubert Kempf

Abstract

Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell [1961]: a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.> This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.

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  • Russell W. Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report 311, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:311
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    Keywords

    monetary unions; Econometric models;

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