The fiscal dimension of a common monetary policy: results with a non-Ricardian global model

This paper studies the interaction of fiscal and monetary policy within an Economic and Monetary Union (EMU). Results suggest that, in a model in which bonds and money are counted as net wealth, the primary source of cross-country heterogeneity in response to a common monetary shock is the differences in national economies' budgetary positions. In particular, we note that centralising seigniorage revenues may lead, in the long term, to wealth redistribution across countries. Although institutional arrangements such as the Stability Pact might not be necessary to ensure fiscal sustainability, its strict enforcement is shown to be associated with overall ever-lasting benefits. Transition to the new steady state appears, however, remarkably costly for high-debt EMU countries. Finally, whereas different degrees of rigidity in labour markets are sufficient to undermine synchronisation in country-specific adjustments to a common monetary shock, different degrees of efficiency characterising European credit markets are per se unlikely to play a major role in explaining asymmetric responses.