The Policy Mix in a Monetary Union: Who Bears the Burden of Asymmetric Shocks' Stabilisation?

Christos Mavrodimitrakis

No em-dp2022-12, Economics Discussion Papers from Department of Economics, University of Reading

Abstract: We utilise a standard reduced-form neo-Keynesian model in a monetary union, in which the monetary authority and the fiscal authorities strategically interact, to explore who, under alternative institutional arrangements (strategic and fiscal regimes) and shocks` configurations, bears the burden of asymmetric shocks` stabilisation. We show that in the core/periphery fiscal regime, described by an asymmetry in the sequence of moves between the core and the peripheral member-states, asymmetric shocks pass through at the union level when there are strategically significant spill-over effects and the monetary policy`s and fiscal policy`s instruments are not perfect substitutes in the stabilisation process. The monetary authority reacts to asymmetric shocks, but does not succeed in fully offsetting them. The first best implies the coordination of fiscal policies. A second best might be achieved by the fiscal leadership strategic regime (a form of implicit coordination), when there are strong interconnections in the union, and/or inducing the fiscal authorities to use fiscal policy instruments that directly decrease inflation, such as taxes, production subsidies or public investment, when there is a strong cost channel of monetary policy.

Keywords: monetary union; strategic interactions; policy mix; core/periphery set-up; asymmetric shocks (search for similar items in EconPapers)
JEL-codes: E52 E61 E62 E63 F45 (search for similar items in EconPapers)
Pages: 13 pages
Date: 2022-11-30
New Economics Papers: this item is included in nep-cba, nep-mon and nep-opm
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