On International Cooperation in Monetary and Fiscal Policy

Master Thesis by Alexander Warren Zieroth
August 5, 2005

Abstract:

I develop a two-country dynamic stochastic general equilibrium model featuring monopolistic competition and staggered price setting with an interest-rate setting rule and distortionary taxes in each country to examine the potential for policy cooperation. I show that a tax on consumption in this framework is very powerful, distorting consumption risk sharing via the real exchange rate. Monetary policy is specified as a simple Taylor Rule common with a closed economy model. Endogenous fiscal policy is effected by means of lagged feedback rules, and two alternatives are compared. Using technology as feedback is not found to be welfare improving compared with random walk taxation and cooperation is to be recommended to overcome mutually disadvantageous unilateral policy making. When output is used as feedback, welfare is improved under cooperation in comparison with random walk taxation.