Monetary-Fiscal Policy Interactions and Commitment versus Discretion in a Monetary Union

Abstract

We consider monetary fiscal policy interactions in a monetary union. If monetary and fiscal authorities have different ideal output and inflation targets, the Nash equilibrium output or inflation or both are beyond the ideal points of all authorities. Leadership of either authority is better. Fiscal discretion entirely negates the advantage of monetary commitment: The optimal monetary rule is equivalent to discretionary leadership of monetary over fiscal policy. Agreement about ideal output and inflation creates a monetary-fiscal symbiosis, yielding the ideal point despite disagreement about the relative weights of the two objectives, for any order of moves, without fiscal co-ordination, and without monetary commitment.

Keywords: Monetary union, Monetary policy, Fiscal policy

JEL Classification: F30, F33, F42