Abstract
In this paper we apply a static version of a New Keynesian macromodel to a monetary union (see Bofinger et al., J Econ Educ, 37:98–117 (2006), Walsh, J Econ Educ, 33:333–346 (2002)). We show in particular that a harmonious functioning of a monetary union critically depends on the correlation of shocks that hit the currency area. Additionally a high degree of integration in product markets is advantageous for the ECB as it prevents national interest rates from driving a wedge between macroeconomic outcomes across member states. In particular small countries are in need for fiscal policy as an independent stabilization agent with room to breath.
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Notes
Throughout the exposition we abstract from the problematic of a zero lower bound which might be binding for the case of large negative demand shocks (Coenen 2003).
Note that we implicitly assume that both macroeconomic agents have an identical output target. For diverging targets see Dixit and Lambertini (2001).
For a paper that focuses more strongly on the political interaction between the national governments and a common central bank see Demertzis et al. (1999).
Note that we do not intend to model alliances between individual member states. For a paper that analysis coalition behaviour see Aarle et al. (2002).
For a critical view that stresses that fiscal shocks itself might be a source of dispersion in output see for instance Canova and Pappa (2003).
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Acknowledgments
The authors would like to thank an anonymous referee, Alexandros Kontonikas, Michael Carlberg, Timo Wollmershäuser and the session participants of the 10th International Conference on Macroeconomic Analysis and International Finance (2006) in Crete for valuable suggestions. The paper was accepted for presentation in Dresden (Annual Meeting of the German Economic Association 2004), Göttingen (6th Göttingen Workshop on International Economic Relations) and Sevilla (XIth Spring Meeting of Young Economists).
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Bofinger, P., Mayer, E. Monetary and Fiscal Policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve. Open Econ Rev 18, 291–305 (2007). https://doi.org/10.1007/s11079-007-9039-3
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DOI: https://doi.org/10.1007/s11079-007-9039-3