International monetary and fiscal policy cooperation in the presence of wage inflexibilities: Are both counterproductive?

Abstract

This paper studies the transmission mechanisms and welfare implications of strategic monetary and fiscal policy in a two-country, Mundell-Fleming, variable supply, stochastic model. The issue of the counterproductivity of policy cooperation, raised by Rogoff (1985), is examined and extended to fiscal policy. It is established that systematic fiscal policy cooperation is productive for a wide range of parameter values that include those of the simple Keynesian model. Cooperation is always productive for policy that is contingent on the realisation of shocks.