Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/152936
Authors: 
Ferrero, Andrea
Year of Publication: 
2005
Series/Report no.: 
ECB Working Paper 502
Abstract: 
This paper addresses the question of the joint conduct of fiscal and monetary policy in a currency union. The problem is studied using a two-country DSGE framework with staggered price setting, monopolistic competition in the goods market, distortionary taxation and nominal debt. The two countries form a currency union but retain fiscal policy independence. The policy problem can be cast in terms of a tractable linear-quadratic setup. The stabilization properties and the welfare implications of the optimal commitment plan are compared with the outcome obtained under simple implementable rules. The central result is that fiscal policy plays a key role to smooth appropriately the impact of idiosyncratic exogenous shocks. Fiscal rules that respond to a measure of real activity have the potential to approximate accurately the optimal plan and lead to large welfare gains as compared to balanced budget rules. Monetary policy shall focus on maintaining price stability.
Subjects: 
Currency union
Flexibility
Optimal Policy
Welfare
JEL: 
E63
F33
F42
Document Type: 
Working Paper

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