Interaction of Fiscal Policies on the Euro Area: How Much Pressure on the ECB?

No ECO2006/9, Economics Working Papers from European University Institute

Abstract: Since the Helsinki European Council of December 1999, a process of increased coordination of fiscal policies in the area of the Euro seems to be on its way. In this paper I examine this process from the point of view of the independence of the European Central Bank (ECB). The interaction of the governments and the ECB is addressed in a game theoretical framework. First, the conditions under which the national governments are able to put pressure on the ECB are made explicit. Then the main question is addressed: would a greater fiscal coordination reduce or increase the capacity of the monetary authority of targeting long run inflation? Formal and informal, discretional (positive) and rule-based (negative) coordination and their interactions are examined as possible solutions of the game. I conclude that the main point is not how much fiscal coordination is there, but the form it takes. It turns out that a mix of informal political coordination and binding rules is the one that best preserves the independence of the ECB. For negative coordination, it is shown that a simple change in the definition of "excessive deficit" can at the same time allow more stabilization of output after a shock and a better control of inflation by the ECB.

Keywords: European Montary Union; European Central Bank; game theory; fiscal policy; monetary policy; policy coordination (search for similar items in EconPapers)
JEL-codes: C7 E0 E3 E6 H5 (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac, nep-mon and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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