Effects of Supply Shock in a Monetary Union Under Rules and Discretion (original) (raw)
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Open Economies Review, 2009
In this paper we extend Nordhaus' (Brookings Pap Econ Act (2):139-199, 1994) results to an environment which may represent the current European situation, characterised by a single monetary authority and several fiscal bodies. We show that, even assuming that the monetary and the fiscal authorities share the same ideal targets, in the presence of asymmetric shocks the "symbiosis" result found by Dixit and Lambertini (J Int Econ 60: [235][236][237][238][239][240][241][242][243][244][245][246][247] 2003) no longer obtains. Thus, fiscal rules as those envisaged in the Maastricht Treaty and in the Stability and Growth Pact may work as monetary/fiscal coordination devices that improve welfare. The imposition of common targets, however, may work as a substitute for policy coordination only if these are made state contingent, an aspect that the recent version of the Stability and Growth Pact takes into account in a more appropriate way than its original version.
Monetary unions under financial shocks: do fiscal rules matter?
Advances on international economics, 2015, ISBN 978-1-4438-7828-9, págs. 39-61, 2015
The recent problems generated by the economic and financial crisis have led to some debate on the role of economic policies. The question is to which extent a specific monetary policy regime would impose a restriction to policymakers. In particular, the cost of losing independence in the use of the exchange rate and monetary policy, and the restrictions derived from the fiscal discipline required for supporting monetary agreements. As an example we can think on the expected success of the European Economic and Monetary Union (EMU), related to the benefits of the single currency, the higher degree of integration of financial markets, and also to the sound public finances guaranteed by the set of fiscal rules provided by EMU. When signing the Stability and Growth Pact (SGP), Member States committed themselves to reach a medium-term budgetary position close to balance. The Maastricht Treaty stresses as basic that the Member States of the EMU should avoid excessive deficits, and the reference values for deficit-to-GDP and debt-to-GDP ratios have worked in fact as an explicit fiscal rule. But, in practice, the policy orientation of the SGP has not been fully satisfied. This has opened a debate about the utility and effectiveness of fiscal rules in EMU, and on their complementarities with discretionary fiscal policy measures and automatic stabilisers to deal with short-run fluctuations. The aim of this paper is to investigate how to deal with monetary (financial) shocks in a monetary union following fiscal rules. In particular, we will analyse the interaction among those members showing a relatively high level of public debt and those that seem to follow a more strict fiscal discipline.
Monetary and Fiscal Policy in a Monetary Union
Society for Economic Dynamics, …, 2005
The idea that a common monetary policy in a monetary union imposes costs when compared with independent policies at the country level is largely widespread in the literature. This result leads directly to a greater emphasis on national Þscal policies. We show in this paper that a common monetary policy has more power to asymmetrically affect countries than is usually stated in the literature. Aggregate shocks in a union where countries are identical but specialized in different goods have asymmetric effects across countries. Should this power to affect asymmetrically countries be used by the monetary authority? The importance of Þscal policy for the answer of this question is also studied in this paper.
1995
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 ro le in stabilizing country-specific shocks than with national monetary policies. Whereas monetary u nification with an optimally designed central bank reduces both expected inflation and the varia nce 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 welf are.
Monetary and Fiscal Stabilization of Demand Shocks Within Europe
Review of International Economics, 1997
This paper examines alternative macroeconomic stabilization rules for demand shocks, for a single open economy, and for an integrated European region. These questions are tackled in two ways. First a very simple macroeconomic model is used to focus on intercountry interconnections. Then the effects of shocks are simulated using the McKibbin Sachs MSG2 global economic model. The theoretical model analyzes just how much larger the disturbances caused by asymmetric shocks might be in a European Monetary Union, as compared with outcomes under floating exchange rates, especially (1) if rigid central monitoring and discipline of fiscal policy prevents the full operation of the inbuilt fiscal stabilizers within individual European countries, and (2) if European monetary policy does not concern itself with fully European objectives. Simulations with the MSG2 model bear out the significance of these risks. They show that a demand shock like GEMU can have strongly negative effects on output in other European countries if either interest rates are raised to counter the demand shock in the originating country, or if, for some reason, fiscal stabilization is not allowed to be as strong as the inbuilt fiscal stabilizers.
The macroeconomic policy mix in a monetary union with flexible inflation targeting
Journal of International Money and Finance, 2008
Policy mix problems may arise in a monetary union with centralized monetary policy and decentralized fiscal policy. A consequence of this may be an inappropriate stabilization of shocks. This paper addresses how policy coordination problems between fiscal authorities depend on the type of shocks and the objectives of the monetary authority. It is shown that non-coordinated fiscal policies tend to be too countercyclical in the case of aggregate shocks, and that this bias can be reduced by lowering the weight to output stability in monetary policy. Oppositely, for country-specific shocks non-coordinated fiscal policies tend to be too pro-cyclical, and this bias can be reduced by increasing the weight to output stability in monetary policy. Considering the assignment of policy tasks e within the set of binding policy rules for fiscal and monetary policies e it is found that flexible inflation targeting dominates strict inflation targeting.
Compatibility between monetary and fiscal policy under EMU
European Economic Review, 2006
The potential importance of fiscal policy in influencing inflation has recently been highlighted, following , under the heading of the 'Fiscal Theory of the Price Level' (FTPL). Some authors have suggested that this theory provides a rationale for the Pact for Stability and Growth as a necessary condition for the ECB pursuing a policy of price stability. In this paper, we relax the assumptions underpinning the FTPL by developing a two country open economy model, where each country has overlapping generations of non-Ricardian consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently. We examine the case where the two countries have formed a monetary union, but where the fiscal authorities remain independent. We show that the fiscal response required to ensure stability of the real debt stock is greater when consumers are not infinitely lived. In principle, this allows for some compensating behaviour between governments, but we show that the scope for compensation is small The monetary authority can abandon its active targeting of inflation to stabilise the debt of at most one fiscal authority, and any other combination of policies will either result in price level indeterminacy and/or indefinite transfers of wealth between the two economies. Finally, in a series of simulations we show that fiscal shocks have limited impact on output and inflation provided the fiscal authorities meet the (weak) requirements of fiscal solvency. However, when monetary policy is forced to abandon its active targeting of inflation, then fiscal shocks have a much greater impact on both output and inflation.
Monetary and Fiscal Policy Rules in the EMU
German Economic Review, 2004
This paper studies the design and effects of monetary and fiscal policy in the euro-area. To do so, a stylised two-region model of monetary and fiscal policy rules in the EMU is built. It is analysed how monetary and fiscal rules affect the adjustment dynamics in the model. Both the effects on the individual countries and on the EMU aggregate economy are studied. Three aspects play an important role in the analysis: (i) the consequences of alternative monetary and fiscal policy rules, (ii) the consequences of asymmetries between EMU countries -asymmetries in macroeconomic shocks and macroeconomic structures-, (iii) the role of alternative degrees of backward and forward-looking behaviour in consumer decisions and inflation expectations. * We gratefully acknowledge the comments by an anonymous referee. The first author acknowledges the financial support from the Fonds voor Wetenschappelijk Onderzoek Vlaanderen (F.W.O.).
Specificity of Fiscal Policy in the Monetary Union
ACTA ECONOMICA, 2018
The condition of the optimal currency area as a theoretical basis of the monetary integration considers the harmonization of the fiscal and monetary policy crucial in achieving the efficient functioning of the monetary union. The issue of sustainability of the monetary union without fiscal union reaches real intensity in times of crisis and market instability. In that context, this paper focuses on the relation of uncoordinated fiscal policies and non-fulfillment of the fiscal criteria of convergence with the functioning and sustainability of the monetary union. The aim of this research is to establish whether, based on the analysed theoretical assumptions and empirical case, the fiscal criteria are respected in practice in the member countries, and how specificity of the fiscal policy influences the monetary integration especially in the years of crisis. We started research with the cost-benefit analysis of the monetary union pointing out to the specific costs and benefits occurrin...
Monetary-Fiscal Policy Interactions in the Euro Area
SSRN Electronic Journal, 2021
The last review of the ECB's monetary policy strategy in 2003 followed a period of predominantly upside risks to price stability. Experience following the 2008 financial crisis has focused renewed attention on the question of how monetary and fiscal policy should best interact, in particular in an environment of structurally low interest rates and persistent downside risks to price stability. This debate has been further intensified by the economic impact of the coronavirus (COVID-19) pandemic. In the euro area, the unique architecture of a monetary union consisting of sovereign Member States, with crosscountry heterogeneities and weaknesses in its overall construction, poses important challenges. Against this background, this report revisits monetary-fiscal policy interactions in the euro area from a monetary policy perspective and with a focus on the ramifications for price stability and maintaining central bank independence and credibility. The report consists of three parts. The first chapter presents a conceptual framework for thinking about monetary-fiscal policy interactions, thereby setting the stage for a discussion of specifically euro area aspects and challenges in subsequent parts of the report. In particular, it reviews the main ingredients of the pre-global financial crisis consensus on monetary-fiscal policy interactions and addresses significant new insights and refinements which have gained prominence since 2003. In doing so, the chapter distinguishes between general conceptual aspects-i.e. those aspects that pertain to an environment characterised by a single central bank and a single fiscal authority and those aspects that pertain to an environment characterised by a single central bank and many fiscal authorities (a multi-country monetary union).