Optimal Monetary and Fiscal Policy in the EMU: Does Fiscal Policy Coordination Matter?

45 Pages Posted: 11 Oct 2009 Last revised: 6 Jan 2011

See all articles by Chiara Forlati

Chiara Forlati

Ecole Polytechnique Fédérale de Lausanne

Date Written: May 1, 2009

Abstract

I develop and analyze a DSGE model of a currency union to revise the question of how to conduct monetary and fiscal policy in countries that share the same currency. In contrast with the previous literature which assumes coordination, this paper analyzes the case where coordination lacks among fiscal authorities as well as between fiscal and monetary authorities. I show that the normative prescriptions emphasized by former analyses are not valid any more once policymakers are not coordinated. Indeed, in that case the common central bank does not stabilize the average union inflation as if it were in a closed economy because it has to take into account the distortions caused by the lack of coordination among fiscal policymakers. At the same time, if there is not a common agreement to coordinate fiscal policies, autonomous governments should use government expenditure as a stabilization tool even if shocks are symmetric.

Keywords: Monetary and Fiscal Policy, Policy Coordination

JEL Classification: E52, E58, E62, F42

Suggested Citation

Forlati, Chiara, Optimal Monetary and Fiscal Policy in the EMU: Does Fiscal Policy Coordination Matter? (May 1, 2009). Center for Fiscal Policy, EPFL, Chair of International Finance (CFI) Working Paper No. 2009-04, Available at SSRN: https://ssrn.com/abstract=1484602 or http://dx.doi.org/10.2139/ssrn.1484602

Chiara Forlati (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Station 5
Odyssea 1.04
1015 Lausanne, CH-1015
Switzerland

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