TY - JOUR
T1 - Overturning Mundell
T2 - Fiscal policy in a monetary union
AU - Cooper, Russell
AU - Kempf, Hubert
N1 - Funding Information:
If q¯ and q¯∗ are equal to 1 and the variability of taste shocks is positive, then by Proposition 6 neither country runs a deficit. Because the money supply is constant, VW = VS. But, due to the taste shocks, VS > VF from Proposition 5 so that VW > VF. By continuity, this holds if q¯ and q¯∗ are near 1. ‖ Acknowledgements. We are grateful to the CNRS and the NSF for financial support. This is a much revised version of our working paper, Cooper and Kempf (2000). The suggestions of two anonymous referees as well as the Managing Editor are appreciated. Comments from seminar participants at Boston College, Boston University, the Federal Reserve Bank of Cleveland, the Federal Reserve Bank of Minneapolis, McMaster University, the University of Pittsburgh, the European University Institute (Florence), CREST (INSEE), GREMAQ (Université de Toulouse), GREQAM (Université Aix-Marseille-II), Université de Lyon and EUREQua (Université Paris-1 Panthéon-Sorbonne) are gratefully acknowledged.
PY - 2004/4
Y1 - 2004/4
N2 - Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell (1961): a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable. This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.
AB - Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell (1961): a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable. This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.
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U2 - 10.1111/0034-6527.00288
DO - 10.1111/0034-6527.00288
M3 - Article
AN - SCOPUS:1942437394
SN - 0034-6527
VL - 71
SP - 371
EP - 396
JO - Review of Economic Studies
JF - Review of Economic Studies
IS - 2
ER -