Fiscal Policies and Monetary Leadership in a Monetary Union with a Deficit-Concerned Central Bank

We consider fiscal and monetary policy interactions in a monetary union under monetary leadership, when the common central bank is concerned with the average fiscal stance of the union. We use a static two-country monetary union model to investigate the policy-mix problem under different regimes of noncooperation, cooperation, and enforced cooperation among fiscal authorities. We find that fiscal policy is unambiguously countercyclical, a feature that is more pronounced under fiscal policy cooperation. Monetary policy can be either countercyclical or procyclical. A central bank concerned about the aggregate fiscal stance is effective in stabilizing output and central budget, but at the expense of inflation stabilization.