Optimal fiscal policy in a monetary union

Abstract

We lay out an optimizing multicountry framework suitable for fiscal policy analysis in a monetary union. We show that, for any given member country, the relinquishment of monetary policy independence, coupled with nominal price rigidity, generates a motive for fiscal stabilization beyond the optimal provision of public goods. This incentive depends on the degree of asymmetry between that country’s and the union average natural rate of interest. Interestingly, this is shown to be the case despite fiscal policy being set, in each individual country, in order to maximize welfare at the level of the union as a whole.

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