| Author: | Agell, J. Calmfors, L. Jonsson, G. |
| Title: | Fiscal policy when monetary policy is tied to the mast |
| Journal: | European Economic Review
1996 : AUG, VOL. 40:7, p. 1413-1440 |
| Index terms: | EUROPEAN MONETARY SYSTEM EXCHANGE RATES FISCAL POLICY |
| Language: | eng |
| Abstract: | The paper analyzes the time inconsistency problem of both exchange rate and fiscal policy in a small open economy. The equilibrium under discretion is characterized by inflation and a deficit. Commitment of the exchange-rate instrument only, e. g. through membership in a European monetary union with low inflation, contributes to price stability but may increase the deficit. Whether the government will prefer the outcome to the discretionary one will depend on the structure of the economy. The paper concludes that the time-inconsistency argument strengthens the case for simultaneous commitment of fiscal and monetary policy for inflation-prone countries which join a monetary union. |
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