Monetary-Fiscal Policy Interactions and Commitment Versus Discretion in a Monetary Union

We consider monetary-fiscal interactions when the monetary authority is more conservative than the fiscal. With both policies discretionary, (1) Nash equilibrium yields lower output and higher price than the ideal points of both authorities, (2) of the two leadership possibilities, fiscal leadership is generally better. With fiscal discretion, monetary commitment yields the same outcome as discretionary monetary leadership for all realizations of shocks. But fiscal commitment is not similarly negated by monetary discretion. Second-best outcomes require either joint commitment, or identical targets for both authorities - output socially optimal and price level appropriately conservative - or complete separation of tasks.

Interactions of Commitment and Discretion in Monetary and Fiscal Policies

/pdf/should-the-european-central-bank-and-the-federal-reserve-be-232hs5w4nu.pdf

Should the European Central Bank and the Federal Reserve Be Concerned About Fiscal Policy

We consider the interaction between the monetary policy of a common central bank in a monetary union, and the separate fiscal policies of the member countries. We construct a model of the Barro-Gordon type extended to many countries and countercyclical fiscal stabilization policies. Each country's fiscal policies inflict positive (output expansion) and negative (inflation) externalities on other countries, and the common monetary policy has its time-consistency problem. But we find that each kind of policy helps solve the other kind's problem. The first-best can be achieved despite the inevitability of some ex post monetary accommodation to fiscal profligacy, without the need for fiscal coordination, without the need for monetary commitment, without the need for a conservative central bank, and irrespective of whether the fiscal or the monetary authorities have the first move.

/pdf/symbiosis-of-monetary-and-fiscal-policies-in-a-monetary-2j00k4dym9.pdf

Symbiosis of Monetary and Fiscal Policies in a Monetary Union

We develop a model in which governments' financing needs exceed the socially optimal level because public resources are diverted to serve the narrow interests of the group in power From a social welfare perspective, this results in undue pressure on the central bank to extract seigniorage Monetary policy also suffers from an expansive bias, owing to the authorities' inability to precommit to price stability Such a conjecture about the fiscal-monetary policy mix appears quite relevant in Africa, with deep implications for the incentives of fiscally heterogeneous countries to form a currency union We calibrate the model to data for West Africa and use it to assess proposed ECOWAS monetary unions Fiscal heterogeneity indeed appears critical in shaping regional currency blocs that would be mutually beneficial for all their members In particular, Nigeria's membership in the configurations currently envisaged would not be in the interests of other ECOWAS countries unless it were accompanied by effective containment on Nigeria's financing needs

Monetary Union in West Africa: Who Might Gain, who Might Lose, and why?

Monetary union without fiscal coordination may discipline policymakers

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Monetary union without fiscal coordination may discipline policymakers