Journal Article

Overturning Mundell: Fiscal Policy in a Monetary Union

Russell Cooper and Hubert Kempf

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 71, issue 2, pages 371-396
Published in print April 2004 | ISSN: 0034-6527
Published online April 2004 | e-ISSN: 1467-937X | DOI: https://dx.doi.org/10.1111/0034-6527.00288
Overturning Mundell: Fiscal Policy in a Monetary Union

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  • Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
  • Monetary Policy, Central Banking, and the Supply of Money and Credit
  • International Finance

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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.

Keywords: E52; E63; F33

Journal Article.  11866 words.  Illustrated.

Subjects: Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook ; Monetary Policy, Central Banking, and the Supply of Money and Credit ; International Finance

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