Fiscal Policy In A Monetary Union: Can Fiscal Cooperation Be Counterproductive?

The authors analyze the interaction of monetary and fiscal policies in a monetary union where the common central bank is more conservative than the fiscal authorities. When monetary and fiscal policies are discretionary, they find that the Nash equilibrium is sub-optimal with higher output and lower inflation than the cooperative Ramsey optimum. In a further example of counterproductive cooperative, they find that fiscal cooperation makes matters worse. They also examine cooperative and non-cooperative fiscal policy in the case where the central bank can commit and has the same preferences as the fiscal authorities.