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Optimal Monetary and Fiscal Policy in a Currency Union


Jordi Galí


Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Tommaso Monacelli


Bocconi University - Department of Economics

December 2005

NBER Working Paper No. w11815

Abstract:     
We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the efficient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper offers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.

Number of Pages in PDF File: 40

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Date posted: February 19, 2006  

Suggested Citation

Galí, Jordi and Monacelli, Tommaso, Optimal Monetary and Fiscal Policy in a Currency Union (December 2005). NBER Working Paper No. w11815. Available at SSRN: http://ssrn.com/abstract=875691

Contact Information

Jordi Gali (Contact Author)
Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )
Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2754 (Phone)
+34 93 542 1746 (Fax)
HOME PAGE: http://www.econ.upf.es/~gali
Massachusetts Institute of Technology (MIT) - Department of Economics ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Tommaso Monacelli
Bocconi University - Department of Economics ( email )
Via Gobbi 5
Milan, 20136
Italy
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