Working Paper: CEPR ID: DP11780
Authors: Thomas Hettig; Gernot Müller
Abstract: According to the pre-crises consensus there are separate domains for monetary and fiscal stabilization in a currency union. While the common monetary policy takes care of union-wide fluctuations, fiscal policies should be tailored to meet country-specific conditions. This separation is no longer optimal, however, if monetary policy is constrained by an effective lower bound on interest rates. Specifically, we show that in this case there are benefits from coordinating fiscal policies across countries. By coordinating on a common fiscal stance, policy makers are able to stabilize union-wide activity and inflation while avoiding detrimental movements of a country's terms of trade.
Keywords: currency union; fiscal policy; effective lower bound; coordination; EMU; terms of trade; externality; optimal policy
JEL Codes: E61; E62; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| coordinated fiscal policy (F42) | improved economic outcomes (O49) |
| coordinated fiscal policies (F42) | stabilization of unionwide activity and inflation (E63) |
| lack of coordination (P11) | significant fiscal stimulus gap (E62) |
| uncoordinated fiscal policies (F42) | insufficient stimulus during economic downturns (E65) |
| coordination (P11) | rise in expected inflation (E31) |
| rise in expected inflation (E31) | lower real interest rates (E43) |
| lower real interest rates (E43) | stimulation of demand (J23) |