ECB vs. Council vs. Commission: Monetary and Fiscal Policy Interactions in the EMU When Cyclical Conditions are Uncertian

Posted: 14 Oct 2008 Last revised: 2 Nov 2008

See all articles by Marco Buti

Marco Buti

European Commission, DG II

Martin Larch

European Fiscal Board

Fabio Balboni

HM Treasury; London School of Economics & Political Science (LSE); University of Bologna - School of Economics, Management, and Statistics

Date Written: April 1, 2007

Abstract

This paper examines economic policy interactions in the Economic and Monetary Union when the assessment of cyclical conditions in real time is surrounded by uncertainty. On the basis of a simple stylised model it shows that with a Nash-type of interaction different views about the output gap on the side of the policy players - the Council of the European Union, the European Commission and the European Central Bank - can give rise to excessive activism with policy players pushing economic variables into opposite directions. It argues that the costs of such policy conflicts can be reduced by agreeing on a common assessment of the cycle, by constraining policy variables, and/or by increasing the weight of fiscally conservative institutions. An alternative option to sidestep policy conflicts ensuing from diverging views of the cycle is to take policy decisions sequentially, as is the case in a Stackelberg-type of interaction. The paper shows that for a given misperception of the cycle, the impact on the policy instruments and on output and inflation are generally smaller in the Stackelberg equilibrium as compared to a Nash outcome. Alternative allocations of roles - that is leader versus follower - are discussed and assessed.

Keywords: Monetary policy, Fiscal Policy, Economic and Monetary Union, real-time output gap estimates

JEL Classification: E5, E61, E62, E63

Suggested Citation

Buti, Marco and Larch, Martin and Balboni, Fabio, ECB vs. Council vs. Commission: Monetary and Fiscal Policy Interactions in the EMU When Cyclical Conditions are Uncertian (April 1, 2007). Empirica, Journal of Applied Economics and Economic Policy, 2009, Available at SSRN: https://ssrn.com/abstract=1284415

Marco Buti

European Commission, DG II ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium
+32 2 296 2246 (Phone)
+32 2 299 3505 (Fax)

Martin Larch (Contact Author)

European Fiscal Board ( email )

Belgium
0032 2 2969244 (Phone)

Fabio Balboni

HM Treasury ( email )

1 Horse Guards Road
London SW1A 2HQ, SW1
United Kingdom

London School of Economics & Political Science (LSE)

Houghton Street
London, WC2A 2AE
United Kingdom

University of Bologna - School of Economics, Management, and Statistics

Piazza Scaravilli 1
40126 Bologna, fc 47100
Italy

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