Strategic Interactions Between Fiscal and Monetary Policies in a Monetary Union

Abstract

This paper develops a dynamic game model to study strategic interactions between policy-makers in a monetary union. In this union, governments of the participating countries pursue national goals when deciding on fiscal policies, whereas the common central bank's monetary policy aims at union-wide objective variables. For a symmetric demand shock, we derive solutions of the dynamic game between the governments and the central bank. The different solution concepts for this dynamic game can be interpreted as models of a conflict between national and supra-national institutions (non-cooperative Nash equilibrium) on the one hand and of coordinated policy-making (cooperative Pareto solutions) on the other.