Independent or Coordinated? Monetary and Fiscal Policy in Emu

29 Pages Posted: 9 Nov 2001

See all articles by Luca Lambertini

Luca Lambertini

University of Bologna - Department of Economics

Riccardo Rovelli

University of Bologna - Department of Economics; IZA Institute of Labor Economics

Date Written: October 5, 2001


We examine, in a suitable theoretical framework, the relations between monetary and fiscal policies within the European Economic and Monetary Union (EMU).

Our stylized setup of EMU includes the following political agents, each endowed with an objective function: (i) A central authority (EC), which aims at maximizing a Social Welfare criterion; (ii) National Fiscal Authorities (FA), which pursue domestic output stabilization, (iii) the European Central Bank (ECB) which has a mandate to stabilize inflation. In this context we ask the following questions:

- How would the EC want to direct (or coordinate) the national FA?

- Do the EC decisions make control of inflation (the ECB mandate) easier or more difficult?

- Do national FA have an incentive to obey to or to deviate from the EC directives?

In response to the last question, our main result is that national FA may have an incentive to deviate, even if we exclude time-inconsistent motives in their preference functions, or motives linked to a failure to internalize aggregate demand spillovers.

In particular, even in the absence of asymmetric shocks and of aggregate demand spillovers, EC authorities and national governments may have conflicting incentives, depending upon the relative size of disturbances to aggregate demand and supply. When both aggregate demand and supply shocks are positive (resp. negative) and the latter are large enough in absolute terms, then national governments will pursue a more expansionary (resp. contractionary) fiscal policy than it would be desirable from the point of view of social welfare.

Our results imply that, if the EC authorities are required to enforce a social welfare function defined over aggregate output and inflation, then it may be necessary to endow the EC with appropriate enforcement devices with respect to the fiscal policy stance of individual member countries.

This points to the necessity of having institutions (such as the Stability and Growth Pact, SGP) which help to coordinate and discipline the fiscal stance of member countries.

While we do not discuss the specific provisions of the SGP, our conclusions strongly support the idea that the setting of fiscal policies by member countries needs to be disciplined, and in some instances possibly over-ruled, by the EC authorities.

Note: This is an extended abstract of the paper.

Keywords: Monetary Policy, Fiscal Policy Rules, Policy Coordination, EMU, Stability and Growth Pact

JEL Classification: E50, E61, E63, H30

Suggested Citation

Lambertini, Luca and Rovelli, Riccardo, Independent or Coordinated? Monetary and Fiscal Policy in Emu (October 5, 2001). Available at SSRN: or

Luca Lambertini

University of Bologna - Department of Economics ( email )

Strada Maggiore 45
Bologna, 40125
+39 051 2092600 (Phone)
+39 051 2092664 (Fax)

Riccardo Rovelli (Contact Author)

University of Bologna - Department of Economics ( email )

Strada Maggiore 45
Bologna, 40125
+39 051 2092 601 (Phone)
+39 051 6402 664 (Fax)

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072

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