Interactions between fiscal and monetary authorities in a three-country new-Keynesian model of a monetary union

In this paper we consider the effectiveness of various coordination arrangements between monetary and fiscal authorities within a monetary union if an economic shock has occurred. We address this problem using a multi-country New-Keynesian model of a monetary union cast in the framework of linear quadratic differential games. Using this model we study various coordination arrangements between fiscal and monetary players, including partial fiscal cooperation between only a subgroup of countries, which, to the best of our knowledge, has not been considered yet in the New-Keynesian literature. Using a simulation study we show that, in many cases and from the global point of view, partial fiscal cooperation between a subgroup of fiscal players is more efficient than non-coordination and that, in general, full cooperation without an appropriate transfer system is not a stable configuration. Furthermore, in case there is no full cooperation we show that the optimal configuration of the coordination structure depends on the type of shock that has occurred. We present a detailed analysis of the relationship between coordination structures and type of shock.