The Unbearable Tightness of Being in a Monetary Union: Fiscal Restrictions and Regional Stability

IGIER Working Paper No. 294

26 Pages Posted: 18 Dec 2005  

Evi Pappa

London School of Economics & Political Science (LSE); Autonomous University of Barcelona - Department of Economics and Economic History

Date Written: December 2004

Abstract

We study how constrained fiscal policy can affect regional inflation and output in a two-region model of a monetary union with sticky prices and distortionary taxation. Both government expenditure and taxes can be used to stabilize regional variables; however, the best welfare outcome is obtained under constant taxes and constant regional inflations. With cooperation debt and deficit constraints reduce regional inflation variability, but the path of output is suboptimal. Under non-cooperation the opposite occurs due to a trade-off between taxation and inflation variability. Decentralized rules, rather than constraints, stabilize regional inflation and output. They imply more fiscal action for smaller union members.

Keywords: Inflation Differentials, Monetary Union, Budgetary Restrictions, Fiscal rules

JEL Classification: E63, F41, F42

Suggested Citation

Pappa, Evi, The Unbearable Tightness of Being in a Monetary Union: Fiscal Restrictions and Regional Stability (December 2004). IGIER Working Paper No. 294. Available at SSRN: https://ssrn.com/abstract=870765 or http://dx.doi.org/10.2139/ssrn.870765

Paraskevi (Evi) Pappa (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7584 (Phone)
+44 20 7831 1840 (Fax)

Autonomous University of Barcelona - Department of Economics and Economic History ( email )

Edifici B - Campus Bellaterra
Barcelona, 08193
Spain

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