King's College London

Research portal

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

Research output: Contribution to journalArticlepeer-review

Original languageEnglish
Pages (from-to)342-361
Number of pages20
JournalJournal of Economic Behavior and Organization
Volume183
DOIs
Published1 Mar 2021

Bibliographical note

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.

King's Authors

Abstract

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.

View graph of relations

© 2020 King's College London | Strand | London WC2R 2LS | England | United Kingdom | Tel +44 (0)20 7836 5454