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
Date Written: April 1, 2007
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: Suggested Citation