Optimal monetary and fiscal policy in a currency union with nontradables

Eiji Okano ()

Macroeconomics and Finance in Emerging Market Economies, 2010, vol. 3, issue 1, 1-23

Abstract: By constructing a dynamic stochastic general equilibrium (DSGE) model, this paper verifies the necessity for an optimal monetary and fiscal policy under a currency union with non-tradable goods. An optimal monetary policy alone can maximize social welfare through stabilizing the producer price inflation and output gap in each country simultaneously when all goods are tradable. However, a solitary optimal monetary policy cannot maximize social welfare because of the Balassa-Samuelson Theorem when non-tradable goods exist. In this case, a cooperative optimal monetary and fiscal policy maximizes social welfare. Also, self-oriented fiscal authority can replicate optimal allocation similar to a cooperative setting.

Keywords: currency union; DSGE; Balassa-Samuelson theorem; optimal monetary policy; monetary and fiscal policy mix (search for similar items in EconPapers)
Date: 2010
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DOI: 10.1080/17520840903498081

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