Fiscal Policy and Macroeconomic Stability within a Currency Union
University of Oxford - Balliol College - Department of Economics; Australian National University (ANU); Centre for Economic Policy Research (CEPR)
University of Glasgow
University of Oxford - Economics Department
CEPR Discussion Paper No. 5584
We analyse the stability of countries within a monetary union in the face of asymmetric shocks, using a simple but widely applicable model. We show that members of the union may be subject to severe, and possibly unstable, cycles following asymmetric shocks if there is a significant backward looking element in inflation behaviour, and if real interest rates influence the level of aggregate demand. This cyclical instability can be mitigated if fiscal policy in each member country reacts to inflation differences, but it can be aggravated if fiscal feedback on debt is too strong.
Number of Pages in PDF File: 29
Keywords: Monetary and fiscal policies, monetary union, macroeconomic stabilityworking papers series
Date posted: June 28, 2006
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