Monetary Union and the Assignment Problem

Abstract

Proposals for the creation of an independent central bank in a European Monetary Union do not always take into account the interactions between monetary and fiscal policy. This analysis describes a system of two similar economies forming either a joint fiscal and monetary union or a simple monetary union. Policy authorities aim to achieve target values for inflation and the budget balance. If the monetary and fiscal authorities pursue their targets independently of each other, there is a risk that unstable interactions will be set up. The results indicate a hazard of the separation of monetary and fiscal management.

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