, Volume 36, Issue 1, pp 21–44 | Cite as

Monetary and fiscal policy interactions in the EMU when cyclical conditions are uncertain

Original Paper


This paper examines economic policy interactions in the Economic and Monetary Union when the assessment of cyclical conditions in real time is surrounded by uncertainty. On the basis of a simple stylised model it shows that with a Nash-type of interaction different views about the output gap on the side of the policy players—the Council of the European Union, the European Commission and the European Central Bank—can give rise to excessive activism with policy players pushing economic variables into opposite directions. It argues that the costs of such policy conflicts can be reduced by agreeing on a common assessment of the cycle, by constraining policy variables, and/or by increasing the weight of fiscally conservative institutions. An alternative option to sidestep policy conflicts ensuing from diverging views of the cycle is to take policy decisions sequentially, as is the case in a Stackelberg-type of interaction. The paper shows that for a given misperception of the cycle, the impact on the policy instruments and on output and inflation are generally smaller in the Stackelberg equilibrium as compared to a Nash outcome. Alternative allocations of roles—that is leader versus follower—are discussed and assessed.


Monetary policy Fiscal policy Economic and Monetary Union Real-time output gap estimates 

JEL Classification

E5 E61 E62 E63 



Helpful comments by Roel Beetsma, Georg Kirchsteiger, Luca Onorante, Alessandro Turrini and two anonymous referees are gratefully acknowledged. Any remaining errors are the sole responsibility of the authors.


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Copyright information

© European Communities 2008

Authors and Affiliations

  1. 1.Directorate-General of Economic and Financial AffairsEuropean CommissionBrusselsBelgium
  2. 2.Bureau of European Policy AdvisersEuropean CommissionBrusselsBelgium
  3. 3.University of BolognaBolognaItaly

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