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Is fiscal policy coordination desirable for a monetary union? An assessment from the perspective of a small open economy

René Cabral, Rocío García Díaz, Noemi Levy, Photis Lysandrou, Alberto Ortiz Bolaños, Carlo Panico and Leonardo Egidio Torre Cepeda
Investigación Económica
Vol. 74, No. 294 (OCTUBRE-DICIEMBRE DE 2015), pp. 3-72
Stable URL: http://www.jstor.org/stable/43630943
Page Count: 70
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Is fiscal policy coordination desirable for a monetary union? An assessment from the perspective of a small open economy
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Abstract

Motivated by the recent experience of Greece and other relatively small European Monetary Union members, this paper examines the appeal of taking part in a large monetary union from the perspective of small open economies. We show that in the absence of fiscal policy considerations, taking part in a large monetary union is counterproductive for a small economy. Nevertheless, once the role of fiscal policy is properly incorporated, taking part in the monetary union becomes desirable from a social perspective. Following these results, we explore the prospects of engaging both economies in fiscal coordination and on how different schemes of policy synchronization can provide the grounds to make cooperation beneficial for the members of a monetary union. We find that when monetary and fiscal authorities cooperate and attempt to exploit externalities for their own benefit, a Pareto efficient outcome can be achieved if fiscal policy in the monetary union is coordinated by a central authority and such authority acts as a the Stackelberg leader vis-à-vis the central bank. Our analysis suggests that this regime is superior to (i) a monetary union in which fiscal authorities conduct their policy in an independent or (ii) coordinated fashion, (iii) a regime where both authorities internalize the effects of their own externalities by allowing the central bank to act as Stackelberg leader and (iv) a regime in which the small open economy decides to stay out of the monetary union. Motivado por la experiencia reciente de Grecia y otros relativamente pequeños miembros de la Unión Monetaria Europea, este trabajo examina la decisión de tomar parte en una gran unión monetaria desde la perspectiva de las economías pequeñas y abiertas. Se demuestra que, en ausencia de consideraciones de política fiscal, el tomar parte en una gran unión monetaria es contraproducente para una economía pequeña. Sin embargo, una vez que el papel de la política fiscal se incorpora adecuadamente, tomar parte en la unión monetaria se vuelve deseable desde una perspectiva social. A raíz de estos resultados, se exploran diferentes esquemas de coordinación de la política fiscal y monetaria para mostrar cómo la cooperación puede beneficiar a los miembros de una unión monetaria. Encontramos que cuando las autoridades monetarias y fiscales cooperan e intentan explotar las externalidades para su propio beneficio, un resultado Pare to eficiente se puede lograr si la política fiscal en la unión monetaria es coordinada por una autoridad central y dicha autoridad actúa como líder à la Stackelberg frente al banco central. Nuestro análisis sugiere que este régimen es superior a (i) una unión monetaria en la que las autoridades fiscales llevan a cabo su política de forma independiente o (ii) de manera coordinada, (iii) un régimen en el que las dos autoridades internalizan los efectos de sus propias externalidades al permitir que el Banco Central actué como líder à la Stackelberg y (iv) un régimen en el que la pequeña economía abierta decide quedarse fuera de la unión monetaria.

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