Working Paper: NBER ID: w9370
Authors: V. V. Chari; Patrick J. Kehoe
Abstract: We analyze the setting of monetary and nonmonetary policies in monetary unions. We show that in these unions a time inconsistency problem in monetary policy leads to a novel type of free- rider problem in the setting of nonmonetary policies, such as labor market policy, fiscal policy, and bank regulation. The free-rider problem leads the union's members to pursue lax nonmonetary policies that induce the monetary authority to generate high inflation. The free-rider problem can be mitigated by imposing constraints on the nonmonetary policies, like unionwide rules on labor market policy, debt constraints on members' fiscal policy, and unionwide regulation of banks. When there is no time inconsistency problem, there is no free-rider problem, and constraints on nonmonetary policies are unnecessary and possibly harmful.
Keywords: No keywords provided
JEL Codes: F3; F31; F33; F34; E4; E42; E58; E61; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| time inconsistency problem (D15) | free rider problem (H40) |
| free rider problem (H40) | high inflation (E31) |
| time inconsistency problem (D15) | high inflation (E31) |
| constraints on nonmonetary policies (E61) | alleviation of free rider problem (H40) |
| effective commitment mechanisms (D70) | elimination of time inconsistency problem (D15) |
| effective commitment mechanisms (D70) | elimination of free rider problem (H40) |
| absence of commitment (J22) | inefficient outcomes in labor market policies (J48) |
| absence of commitment (J22) | inefficient outcomes in fiscal policies (H30) |
| absence of commitment (J22) | inefficient outcomes in bank regulations (G28) |