DP1975 The Optimality of a Monetary Union Without a Fiscal Union

Author(s): Roel Beetsma , A Lans Bovenberg

Publication Date: September 1998

Keyword(s): Fiscal Discipline , fiscal transfer scheme , Inflation Targets , Monetary Union , Moral Hazard

JEL(s): E52 , E58 , E61 , E62 , F42

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP1975.asp

The paper explores the case for monetary and fiscal unification. Monetary policy suffers from an inflation bias because the monetary authorities are not able to commit. With international risk-sharing in a fiscal union, fiscal discipline suffers from moral hazard. An inflation target alleviates the inflation bias but weakens fiscal discipline. In a monetary union, however, this adverse effect on fiscal discipline is weaker. This advantage of monetary unification may outweigh the disadvantage of not being able to employ monetary policy to stabilize country-specific shocks. While monetary unification may thus be optimal, international risk-sharing may be undesirable because it weakens fiscal discipline.