The Optimal Monetary and Fiscal Policy Mix in a Financially Heterogeneous Monetary Union

Jakob Palek (palek@uni-kassel.de)
Additional contact information
Jakob Palek: University of Kassel

MAGKS Papers on Economics from Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung)

Abstract: Recent work on financial frictions in New Keynesian models suggest that there is a sizable spread between the risk-less interest rate and the borrowing rate. We analyze the optimal policy mix of monetary and fiscal authorities in a currency union with a country-specific credit spread by introducing a cost channel differential. The cost channel decreases the efficiency of monetary policy and increases the need for fiscal stabilization. We show that the importance of fiscal policy in stabilizing shocks increases, when there is a gap in the inflation differential due to a relative shock, an idiosyncratic shock or a credit spread differential. The welfare losses will be increasing (decreasing) in the size of the cost channel, if the nominal interest rate is a demand- (supply-) side instrument.

Keywords: cost channel; financial frictions; credit spreads; optimal monetary policy; fiscal policy; monetary union (search for similar items in EconPapers)
JEL-codes: E31 E52 E62 E63 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2015
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Forthcoming in

Downloads: (external link)
http://www.uni-marburg.de/fb02/makro/forschung/mag ... 15/06-2015_palek.pdf First 201506 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:mar:magkse:201506

Access Statistics for this paper

More papers in MAGKS Papers on Economics from Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) Contact information at EDIRC.
Bibliographic data for series maintained by Bernd Hayo (hayo@wiwi.uni-marburg.de).