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Mark-Up Fluctuations and Fiscal Policy Stabilization in a Monetary Union

Roel Beetsma and Henrik Jensen ()

No 4020, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study optimal monetary and fiscal stabilization policy in a two-country monetary union in the presence of (inefficient) mark-up shocks, price rigidities and monopolistic competition. The underlying dynamic system contains two Phillips curves featuring public spending and mark-up shocks. We derive the second-order welfare loss approximation and characterize optimal monetary and fiscal policies under commitment and discretion. With symmetric rigidities, fiscal policy will not be employed in stabilizing union-level variables. Relative spending levels, however, are used to stabilize relative inflation rates and the terms of trade. Under commitment, both monetary policy and relative spending are inertial, while this is not the case under discretion. We conduct numerical analyses to assess the welfare gains from commitment and from having resource to fiscal stabilization. These gains are substantial. We conclude by investigating some simple monetary and fiscal policy rules. The former are based on the standard Taylor rule, while the fiscal rules link spending to output gaps. With mark-up shocks, the optimal fiscal rules are pro-cyclical. Finally, we find that welfare gains are obtained by making the rules inertial.

Keywords: commitment; discretion; mark-up shocks; monetary union; optimal monetary and fiscal policies; policy rules (search for similar items in EconPapers)
JEL-codes: E52 E61 E63 F41 (search for similar items in EconPapers)
Date: 2003-08
New Economics Papers: this item is included in nep-eec, nep-ifn and nep-mac
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Journal Article: Mark-up fluctuations and fiscal policy stabilization in a monetary union (2004) Downloads
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