Working Paper: CEPR ID: DP214
Authors: George Alogoskoufis
Abstract: In this paper I examine issues of optimal stabilization in two types of world economy, a competitive one where all countries are small, and one where there is a Stackelberg leader. The focus is on the 1985 target zones proposal of Williamson, according to which there should be a periodic fixing of exchange rates at levels consistent with equilibrium real rates. World monetary policy should be assigned to the objective of international monetary stability and domestic stabilization policies to the internal balance objectives of individual economies. In a first-best world, where all economies use both monetary and fiscal policy, this appears to be the optimal arrangement. In a second-best world, where fiscal policy cannot be used, the additional constraint imposed by target zones might hinder rather than promote world stabilization. However, if the only country constrained in its use of fiscal policy is the Stackelberg leader, target zones might reproduce the optimal world monetary arrangement quite closely.
Keywords: optimal stabilization; policy; monetary and fiscal policy; exchange rates; target zones
JEL Codes: 432
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fiscal policy (E62) | unemployment stability (J64) |
| monetary policy (E52) | monetary stability (E63) |
| target zones (R32) | increased welfare costs due to fiscal constraints (H53) |
| Stackelberg leader fiscal constraints (E62) | target zones approximate optimal arrangements (R32) |