Abstract/Summary

This paper utilises a static representation of a reduced-form Dynamic Stochastic General Equilibrium (DSGE) model to deal with strategic fiscal/monetary policy interactions in a core-periphery monetary union, in which the periphery member's fiscal authority is always the follower(except in the EMU benchmark where all policymakers move simultaneously).In such a set-up, we examine the policy mix of the alternative institutional arrangements of (i) non-cooperation between the two leading authorities, the lead fiscal authority and the monetary authority; and (ii) in a regime of cooperation between the leaders; and (iii) in a regime of fiscal leadership in which the monetary authority moves between the two fiscal authorities. We explore the welfare implications of these alternative institutional arrangements for the monetary authority, the two fiscal authorities, the social planner, and provide a ranking. Our main results are: (i) the lead fiscal authority's ability to contribute less counter-cyclically increases with cooperation at the core, while it is unchanged for explicit or implicit cooperation system wide; (ii) monetary leadership provides no advantage over no cooperation in the core; (iii) the ranking for the core member's fiscal authority is shock independent and favours a cooperative strategic regime, and then fiscal leadership; (iv) the ranking for the other authorities and the social planner is shock dependent, and can either coincide with or be the exact opposite of the core member's ranking; (v) the ranking for the peripheral fiscal authority always coincides with the social planner's; and (vi) for common supply shocks, all the policy authorities and the social planner are in favour of the cooperative strategic regime.