On optimal monetary and fiscal policy interactions in open economies

Chiara Forlati (c.forlati@soton.ac.uk)

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

Abstract: This paper studies monetary and fiscal policy interactions in a two country model, where taxes on firms’ sales are optimally chosen and the monetary policy is set cooperatively. It turns out that in a two country setting non-cooperative fiscal policy makers have an incentive to change taxes on sales depending on shocks realizations in order to reduce output production. Therefore whether the fiscal policy is set cooperatively or not matters for optimal monetary policy decisions. Indeed, as already shown in the literature, the cooperative monetary policy maker implements the flexible price allocation only when special conditions on the value of the distortions underlying the economy are met. However, if non-cooperative fiscal policy makers set the taxes on firms’ sales depending on shocks realizations, these conditions cannot be satisfied; conversely, when fiscal policy is cooperative, these conditions are fulfilled. We conclude that whether implementing the flexible price allocation is optimal or not depends on the fiscal policy regime.

Keywords: Monetary and Fiscal Policy; Policy Coordination (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 F42 (search for similar items in EconPapers)
Date: 2004-07, Revised 2006-03
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-pbe
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Persistent link: https://EconPapers.repec.org/RePEc:upf:upfgen:949

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