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Advisor(s)
Abstract(s)
Within a country-size asymmetric monetary union, idiosyncratic shocks
and national fiscal stabilization policies cause asymmetric cross-border effects.
These effects are a source of strategic interactions between noncoordinated
fiscal and monetary policies: on the one hand, due to larger
externalities imposed on the union, large countries face less incentives
to develop free-riding fiscal policies; on the other hand, a larger strategic
position vis-à-vis the central bank incentives the use of fiscal policy
to, deliberately, influence monetary policy. Additionally, the existence
of non-distortionary government financing may also shape policy interactions.
As a result, optimal policy regimes may diverge not only across the
union members, but also between the latter and the monetary union.
In a two-country micro-founded New-Keynesian model for a monetary
union, we consider two fiscal policy scenarios: (i) lump-sum taxes are
raised to fully finance the government budget and (ii) lump-sum taxes do
not ensure balanced budgets in each period; therefore, fiscal and monetary
policies are expected to impinge on debt sustainability. For several degrees
of country-size asymmetry, we compute optimal discretionary and
dynamic non-cooperative policy games and compare their stabilization
performance using a union-wide welfare measure. We also assess whether
these outcomes could be improved, for the monetary union, through institutional
policy arrangements.
We find that, in the presence of government indebtedness, monetary
policy optimally deviates from macroeconomic to debt stabilization. We
also find that policy cooperation is always welfare increasing for the monetary
union as a whole; however, indebted large countries may strongly
oppose to this arrangement in favour of fiscal leadership. In this case,
delegation of monetary policy to a conservative central bank proves to be
fruitful to improve the union’s welfare.
Description
Keywords
Monetary union Optimal fiscal and monetary policies Asymmetric countries