Staying together or breaking apart: policy-makers’ endogenous coalitions formation in the European Economic and Monetary Union

Abstract

In this paper, we analyze the coordination of macroeconomic stabilization policies within the EMU by focusing, in a dynamic set-up, on asymmetries and externalities between EMU countries. We study how coalitions among fiscal and monetary authorities are formed and what are their effects on the stabilization of output and prices. In particular, our attention is directed to study the consequences on these issues of different institutional contexts in which policy-makers may act. To do so, a stylized macroeconomic model of EMU is built and a framework of policy coordination introduced. Numerical simulations illustrate the main workings of the model. It is found that in the case of symmetric shocks, full cooperation is always a likely equilibrium, except for the perfectly symmetric setting. Asymmetric shocks tend to reduce the scope for cooperation. In the case of anti-symmetric shocks the coalition formation is most sensitive to procedural aspects and also to asymmetries in parameters and bargaining weights. Asymmetries in structural parameters, bargaining powers and policy preferences may have a sizable effect on (optimal) policies, coalition formation and adjustments in the monetary union.