DP5584 Fiscal Policy and Macroeconomic Stability Within a Currency Union
|Author(s):||Tatiana Kirsanova, David Vines, Simon Wren-Lewis|
|Publication Date:||March 2006|
|Keyword(s):||macroeconomic stability, monetary and fiscal policies, monetary union|
|JEL(s):||E52, E61, E63, F41|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=5584|
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.