Publication

Optimal Fiscal Policy in a Monetary Union

2007
Working Papers

Abstract

We study optimal fiscal policy in a monetary union where monetary policy is decided by an independent central bank. We consider a two-country model with trade in goods and assets, augmented with sticky prices, labor income taxes and stochastic government consumption. It is optimal to finance a shock in part by running deficits and in part by raising the labor income tax, even though the latter is distortionary. The optimal speed of adjustment of budget deficits is much higher than the benchmark adjustment of 0.5 percent of GDP per year required by the recent revision of the Stability and Growth Pact (SGP). Optimal fiscal policy does not depend on the initial level of public debt. Ramsey monetary policy allows for less aggressive and more expansionary response of fiscal policy than the monetary policy implied by an interest rates rule.

Official source

https://infoscience.epfl.ch/entities/publication/ac9cd749-bea7-4f69-b659-1443f24fdcbe

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2007
Working Papers

Abstract

Official source

https://infoscience.epfl.ch/entities/publication/ac9cd749-bea7-4f69-b659-1443f24fdcbe

About this result

Related concepts (32)

Monetary policy

Monetary policy is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rate of inflation). Further purposes of a monetary policy may be to contribute to economic stability or to maintain predictable exchange rates with other currencies.

Fiscal policy

In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable.

Deficit spending

Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget of a government, private company, or individual. Government deficit spending was first identified as a necessary economic tool by John Maynard Keynes in the wake of the Great Depression. It is a central point of controversy in economics, as discussed below.

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Optimal Fiscal Policy in a Monetary Union

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