Abstract
An adverse supply shock hits a two-country Mundell-Fleming world and causes unemployment and a higher cost of living. The optimal budgetary policies under non-cooperative and under international policy coordination are then contrasted under a regime of floating exchange rates, a regime of managed exchange rates with hegemony (such as the EMS), and a symmetric regime of fixed exchange rates (such as the EMU). The welfare loss depends on unemployment, real wage income and budgetary imbalance. Attention is also paid to the effects of indexation of wages on the cost of living and of interactions between Europe and the US. The results shed some light on the short-run stabilisation aspects of the proposals of the Delors Committee for economic and monetary union in Europe.
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