FISCAL-POLICY COORDINATION AND EMU - A DYNAMIC GAME APPROACH

This paper examines the case for fiscal policy coordination in a European Economic and Monetary Union (EMU). A two-bloc model with two market structures is examined: EMU producing a single homogeneous good in both blocs (EMU1) and a two-good EMU (EMU2) where each bloc produces a single 'home' good. The European Central Bank sets monetary policy so as to achieve credibly low inflation rates. We find that for EMU2, as relative prices can change, countries have an incentive to improve their terms of trade leading to an inefficient noncooperative outcome which can be avoided by cooperation.