Fiscal Policy in a Currency Union at the Zero Lower Bound

46 Pages Posted: 14 Mar 2018

See all articles by David E. Cook

David E. Cook

Hong Kong University of Science & Technology (HKUST) - Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Michael B. Devereux

University of British Columbia (UBC) - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: January 26, 2018

Abstract

When monetary policy is constrained by the zero lower bound, fiscal policy can be used to achieve macro stabilization objectives. At the same time, fiscal policy is also a key policy variable within a single currency area that allow policy makers to respond to regional demand asymmetries. How do these two uses of fiscal policy interact with one another? Is there an inherent conflict between the two objectives? How do the answers to these questions depend on the degree of fiscal space available to different members of the currency area? This paper constructs a two-country New Keynesian model of a currency union to address these questions. We find that the answers depend sensitively on the underlying internal structure of the currency union, notably the degree of trade openness between the members of the union.

Keywords: liquidity trap, monetary policy, fiscal policy, international spillovers

JEL Classification: E2, E5, E6

Suggested Citation

Cook, David E. and Devereux, Michael B., Fiscal Policy in a Currency Union at the Zero Lower Bound (January 26, 2018). ADBI Working Paper 801. Available at SSRN: https://ssrn.com/abstract=3140093 or http://dx.doi.org/10.2139/ssrn.3140093

David E. Cook (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China
2538 7614 (Phone)

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China
2538 7614 (Phone)

Michael B. Devereux

University of British Columbia (UBC) - Department of Economics ( email )

997-1873 East Mall
Vancouver, BC V6T 1Z1
Canada
604-822-2542 (Phone)
604-946-6271 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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