Inflation Persistence, Fiscal Constraints and Non-Cooperative Authorities: The Stabilisation Policy in a Monetary Union
University of Exeter Department of Economics Working Paper
37 Pages Posted: 7 Jun 2005
Date Written: March 5, 2005
This paper investigates the importance of fiscal policy in providing macroeconomic stabilisation in a monetary union. We use a microfounded New Keynesian model of a monetary union which incorporates persistence in inflation, and examine non-cooperative interactions of fiscal and monetary authorities. We find that particularly when inflation is persistent, the use of fiscal policy for stabilisation can significantly improve welfare over and above that which arises through the working of automatic stabilisers. We conclude that a regulatory framework for fiscal policy in a monetary union should allow a role for active fiscal stabilisation.
Keywords: Optimal monetary and fiscal policies, Monetary union, Asymmetric Shocks
JEL Classification: E31, E52, E58, E61, C61
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