On the efficiency of monetary and fiscal policy in open economies

This paper investigates the efficiency of monetary and fiscal policy in a two-country general equilibrium model with monopolistic competition and wage stickiness. When monopoly distortions are completely eliminated, we find that stochastic government spending can affect the efficiency of the global monetary policy that replicates the real allocation under flexible wages. When the stochastic government spending is present, we find that the monopoly distortions can also affect the efficiency of the global monetary policy that replicates the real allocation under flexible wages. The combination of proportional subsidy policies used to completely eliminate monopoly distortions and the monetary policy replicating the real allocation under flexible wages can be improved after we introduce the stochastic government spending. Fiscal policy is found to be unable to replicate the real allocation under flexible wages.