DP1380 Monetary Cohabitation in Europe

Author(s): Torsten Persson, Guido Tabellini
Publication Date: May 1996
Keyword(s): EMU, Inflation Targets, Policy Coordination
JEL(s): E42, E52, F33, F42
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1380

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.