Double discretion, international spillovers and the welfare implications of monetary unification

This paper develops a monetary-fiscal game which stresses the importance of international spillovers and introduces a double (monetary and fiscal) credibility problem. Models that neglect the inability of fiscal policymakers to commit will tend to underestimate the welfare cost of structural distortions. Due to international spillovers, stochastic shocks may be relatively costly in welfare terms, despite the contribution of policy surprises to finance such shocks. The second part of the paper studies the welfare consequences of the monetary union. It is shown that the welfare impact of EMU for Europe is ambiguous, but that EMU is welfare-improving for the US.

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