Working Paper: CEPR ID: DP1380
Authors: Torsten Persson; Guido Tabellini
Abstract: How can monetary policy in stage III of European Monetary Union be coordinated between the ?ins? and the ?outs?? This paper compares alternative institutional mechanisms, and concludes that a generalized system of inflation targets at the European level has several merits: it strengthens domestic credibility of monetary policy; it rules out deliberate attempts to gain competitiveness through devaluations; it forces monetary policy to respond automatically to various macroeconomic shocks, which is stabilizing for the real exchange rate; and it distributes these shocks symmetrically across countries. On the basis of a simple theoretical model of policy coordination, the paper shows that a system of inflation targets approximates an optimal policy of international cooperation. Preliminary empirical evidence supports these theoretical results.
Keywords: EMU; inflation targets; policy coordination
JEL Codes: E42; E52; F33; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Inflation targets (E31) | strengthen domestic credibility of monetary policy (E52) |
| Inflation targeting (E31) | rules out competitive devaluations (F31) |
| Inflation targeting (E31) | stabilize the real exchange rate (F31) |
| Inflation targeting (E31) | forces monetary policy to respond automatically to macroeconomic shocks (E61) |
| Without inflation targeting (E31) | destabilizing fluctuations in the exchange rate (F31) |
| Countries adopting inflation targeting (E52) | lower volatility in real exchange rates (F31) |