Working Paper: CEPR ID: DP5584
Authors: Tatiana Kirsanova; David Vines; Simon Wren-Lewis
Abstract: We analyse the stability of countries within a monetary union in the face of asymmetric shocks, using a simple but widely applicable model. We show that members of the union may be subject to severe, and possibly unstable, cycles following asymmetric shocks if there is a significant backward looking element in inflation behaviour, and if real interest rates influence the level of aggregate demand. This cyclical instability can be mitigated if fiscal policy in each member country reacts to inflation differences, but it can be aggravated if fiscal feedback on debt is too strong.
Keywords: macroeconomic stability; monetary and fiscal policies; monetary union
JEL Codes: E52; E61; E63; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation behavior (E31) | cyclical instability (E32) |
| fiscal policy responds to inflation differences (E62) | dampen cyclical instability (E32) |
| excessive fiscal feedback on debt (E62) | increased instability (C62) |