Efficient Fiscal Policy Restrictions in a Monetary Union

Costas Azariadis and Raphael W. K. Lam
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Raphael W. K. Lam: Washington University in St. Louis, and Federal Reserve Bank of St. Louis

A chapter in International Trade and Economic Dynamics, 2009, pp 345-360 from Springer

Abstract: We study the interactions of monetary and fiscal policies in the context of a monetary union. Tensions over fiscal policies have become one of the key issues in the operation in the European Union. We analyze restrictions on public debt in a monetary union in which a patient central bank plays a one-shot Stackel-berg game against a number of impatient fiscal authorities in a simple environment without uncertainty. The noncooperative outcome of this game is excessive borrowing relative to the planning optimum. This will drive up the inflation target as the central bank attempts to minimize the impact of higher yields on borrowing member nations. Fiscal borrowing constraints on member nations improve economic coordination by bringing public deficits more in line with household desires, in turn reducing the pressure on the central bank to inflate its way to lower real yields. We show, in particular, that there exist fiscal constraints supporting the cooperative allocation as a Stackelberg equilibrium.

Keywords: Monetary Policy; Central Bank; Public Debt; Social Welfare Function; Monetary Union (search for similar items in EconPapers)
Date: 2009
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-540-78676-4_24

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DOI: 10.1007/978-3-540-78676-4_24

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