Monetary and Fiscal Policy Games and Effects of Institutional Differences between the European Union and the Rest of the World

Pierre-Henri Faure

Revue économique, 2003, vol. 54, issue 5, 937-959

Abstract: The paper deals with monetary and fiscal policy strategic interactions between the European Union and the rest of the world. We use a three-country Mundell-Fleming model to analyze the policy-makers? responses to a negative global productivity shock. The results obtained in a fully non-cooperative setting indicate that the monetary domination equilibrium harms social welfare; the Stackelberg situation in which governments lead is better and can be seen as a second-best form of intra-zone cooperation. The highest welfare gains stem from the joint setting of policies within each continent, that is, from the adjustment of the domestic policy-mix: solving the target conflict between independent national authorities is more important than international cooperation. Another result is that delegating the control of the common monetary policy to a very conservative central banker in Europe deteriorates welfare all over the world.

Date: 2003
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