Policy conflict, coordination, and leadership in a monetary union under imperfect instrument substitutability

Georgios Chortareas and Christos Mavrodimitrakis

Journal of Economic Behavior & Organization, 2021, vol. 183, issue C, 342-361

Abstract: This paper investigates the implications of strategic fiscal-monetary policy interactions on the policy mix and coordination in a monetary union under imperfect policy instrument substitutability. We develop a model that incorporates the key features of the New-Keynesian framework augmented by a cost channel of monetary policy. Both policy instruments can directly affect inflation, hence having supply-side effects, too. We consider alternative strategic and fiscal regimes. We show that relative policy effectiveness and the cost-channel effect together define policy-mix outcomes, policies’ cyclicality, and coordination problems. The cost channel limits union-wide demand shocks’ stabilization, the monetary authority can no longer manage the cycle, and cooperation and commitment irrelevance do not hold anymore. The lead authority reacts to the follower authority's reaction parameter, hence to the follower's preference parameter, while it might choose not to trade-off its objectives. In the leadership strategic regimes for demand-side policy instruments, the leader reacts positively/negatively to the follower's preference parameter, if its instrument is more/less effective in stabilizing inflation (relative to aggregate demand) than the follower's policy instrument.

Keywords: Monetary union; Fiscal/monetary policies; Cost channel of monetary policy; Strategic interactions; Coordination; Relative policy effectiveness; Policy mix (search for similar items in EconPapers)
JEL-codes: E52 E61 E62 E63 F45 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:183:y:2021:i:c:p:342-361

DOI: 10.1016/j.jebo.2021.01.001

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