How Do Monetary and Fiscal Policy Interact in the European Monetary Union?

72 Pages Posted: 16 Sep 2012

See all articles by Matthew B. Canzoneri

Matthew B. Canzoneri

Georgetown University

Robert E. Cumby

Georgetown University - Department of Economics; National Bureau of Economic Research (NBER)

Behzad Diba

Georgetown University

Date Written: January 2005

Abstract

Formation of the Euro area raises new questions about the coordination of monetary and fiscal policy. Using a New Neoclassical Synthesis (NNS) model, we show that a common monetary policy, responding to area-wide aggregates, has asymmetric effects on countries within the union, depending on whether they are large or small, or whether they have high or low debts. We analyze the implications of these asymmetries for the various countries welfare and for their fiscal policies. We also study rules for setting national tax and spending rates, rules that constrain movements in the deficit to GDP ratio. We ask whether these rules are necessary for the common monetary policy to be able to harmonize national inflation rates, and we analyze their effects on national welfare. We also discuss some potential failings of our model (and perhaps NNS models generally); in particular, our model's variance decompositions suggest that productivity shocks may play an inordinately large role, while fiscal shocks (or demand shocks generally) may play too small a role (even when 'rule of thumb' spenders are added).

Suggested Citation

Canzoneri, Matthew B. and Cumby, Robert E. and Diba, Bezhad, How Do Monetary and Fiscal Policy Interact in the European Monetary Union? (January 2005). NBER Working Paper No. w11055. Available at SSRN: https://ssrn.com/abstract=2147291

Matthew B. Canzoneri (Contact Author)

Georgetown University ( email )

Washington, DC 20057
United States
202-687-5911 (Phone)
202-687-6102 (Fax)

Robert E. Cumby

Georgetown University - Department of Economics ( email )

580 Intercultural Center
Washington, DC 20057
United States
202-687-2990 (Phone)
202-687-6102 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Bezhad Diba

Georgetown University ( email )

Washington, DC 20057
United States
2026875682 (Phone)
2026876102 (Fax)

HOME PAGE: http://econ.georgetown.edu/

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