Monetary and Fiscal Policy Games and Effects of Institutional Differences between the European Union and the Rest of the World

The paper deals with monetary and fiscal policy strategic interactions between the European Union and the rest of the world. We use a three-country Mundell-Fleming model to analyze the policy-makers?' responses to a negative global productivity shock. The results obtained in a fully non-cooperative setting indicate that the monetary domination equilibrium harms social welfare; the Stackelberg situation in which governments lead is better and can be seen as a second-best form of intra-zone cooperation. The highest welfare gains stem from the joint setting of policies within each continent, that is, from the adjustment of the domestic policy-mix: solving the target conflict between independent national authorities is more important than international cooperation. Another result is that delegating the control of the common monetary policy to a very conservative central banker in Europe deteriorates welfare all over the world.