Policy conflict, coordination, and leadership in a monetary union under imperfect instrument substitutability

TY - JOUR

T1 - Policy conflict, coordination, and leadership in a monetary union under imperfect instrument substitutability

AU - Chortareas, Georgios

AU - Mavrodimitrakis, Christos

N1 - Funding Information: We are grateful to the Editor, Professor Daniela Puzzello, and to two anonymous referees for their insightful comments. We are also grateful to the late Prof. Andrew Hughes Hallett for his comments. Earlier versions of the paper have been presented at the Money Macro Finance annual conference 2017 at King's College London, the European Economics and Finance Society annual conference 2018 at City, University of London, a workshop on European macroeconomics at the University of Strasbourg, and seminars at the Schar School of Policy and Government, George Mason University, and Nottingham Business School, Nottingham Trent University. All remaining errors are the responsibility of the authors. We declare no conflicts of interest. Publisher Copyright: © 2021 Elsevier B.V. Copyright: Copyright 2021 Elsevier B.V., All rights reserved.

PY - 2021/3/1

Y1 - 2021/3/1

N2 - This paper investigates the implications of strategic fiscal-monetary policy interactions on the policy mix and coordination in a monetary union under imperfect policy instrument substitutability. We develop a model that incorporates the key features of the New-Keynesian framework augmented by a cost channel of monetary policy. Both policy instruments can directly affect inflation, hence having supply-side effects, too. We consider alternative strategic and fiscal regimes. We show that relative policy effectiveness and the cost-channel effect together define policy-mix outcomes, policies’ cyclicality, and coordination problems. The cost channel limits union-wide demand shocks’ stabilization, the monetary authority can no longer manage the cycle, and cooperation and commitment irrelevance do not hold anymore. The lead authority reacts to the follower authority’s reaction parameter, hence to the follower’s preference parameter, while it might choose not to trade-off its objectives. In the leadership strategic regimes for demand-side policy instruments, the leader reacts positively/negatively to the follower’s preference parameter, if its instrument is more/less effective in stabilizing inflation (relative to aggregate demand) than the follower’s policy instrument.

AB - This paper investigates the implications of strategic fiscal-monetary policy interactions on the policy mix and coordination in a monetary union under imperfect policy instrument substitutability. We develop a model that incorporates the key features of the New-Keynesian framework augmented by a cost channel of monetary policy. Both policy instruments can directly affect inflation, hence having supply-side effects, too. We consider alternative strategic and fiscal regimes. We show that relative policy effectiveness and the cost-channel effect together define policy-mix outcomes, policies’ cyclicality, and coordination problems. The cost channel limits union-wide demand shocks’ stabilization, the monetary authority can no longer manage the cycle, and cooperation and commitment irrelevance do not hold anymore. The lead authority reacts to the follower authority’s reaction parameter, hence to the follower’s preference parameter, while it might choose not to trade-off its objectives. In the leadership strategic regimes for demand-side policy instruments, the leader reacts positively/negatively to the follower’s preference parameter, if its instrument is more/less effective in stabilizing inflation (relative to aggregate demand) than the follower’s policy instrument.

KW - Monetary union; Fiscal/monetary policies; Cost channel of monetary policy; Strategic interactions; Coordination; Relative policy effectiveness; Policy mix

UR - http://www.scopus.com/inward/record.url?scp=85099814201&partnerID=8YFLogxK

U2 - 10.1016/j.jebo.2021.01.001

DO - 10.1016/j.jebo.2021.01.001

M3 - Article

SN - 0167-2681

VL - 183

SP - 342

EP - 361

JO - Journal of Economic Behavior and Organization

JF - Journal of Economic Behavior and Organization

ER -