Optimal Monetary and Fiscal Policy in a Currency Union

Jordi Gali () and Tommaso Monacelli

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and study its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal cooperative policy arrangement requires that inflation be stabilized at the union level by the common central bank, while fiscal policy is used by each country for stabilization purposes. By contrast, when the fiscal authorities act in a non-coordinated way, their joint actions lead to a suboptimal outcome, and make the common central bank face a trade-off between inflation and output gap stabilization at the union level.

Keywords: Monetary union; sticky prices; countercyclical policy; inflation differentials (search for similar items in EconPapers)
JEL-codes: E52 F41 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2005-10, Revised 2008-02
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Related works:
Working Paper: Optimal Monetary and Fiscal Policy in a Currency Union (2005)
Working Paper: Optimal Monetary and Fiscal Policy in a Currency Union (2005)
Working Paper: Optimal Monetary and Fiscal Policy in a Currency Union (2005)
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Persistent link: http://EconPapers.repec.org/RePEc:upf:upfgen:909

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