TY - JOUR
T1 - INFLATION STABILIZATION and DEFAULT RISK in A CURRENCY UNION
AU - Okano, Eiji
AU - Hamano, Masashige
N1 - Funding Information:
Okano Eiji Hamano Masashige Jawadi Fredj Nagoya City University Waseda University The authors would like to thank Alexandre Caboussat, John Barrdear, John Drifill, Masataka Eguchi, Kazuyuki Inagaki, Takashi Kano, Shigeto Kitano, Keiichiro Kobayashi, Chikafumi Nakamura, Tomomi Miyazaki, Eiji Ogawa, Shin-ichi Nishiyama, Etsuro Shioji, Akira Yakita, Naoyuki Yoshino, conference and seminar participants at Cardiff University, Chukyo University, the ESSCA Business School, the Imperial Queen's Park Hotel (Bangkok), Kyushu University, Nagoya City University, Mandarin Orchard (Singapore), Meisei University, Niigata University, Otaru University of Commerce, Queensland University of Technology, Silken Diagonal Barcelona, Yamaguchi University, Sophia University, and two anonymous referees for their helpful comments. Any errors are our own. This work was supported by JSPS KAKENHI Grant Number 25380400. Address correspondence to: Eiji Okano, Graduate School of Economics , Nagoya City University , 1 , Aza , Yamanobata , Mizuhocho , Mizuho-ku , Nagoya-shi , Aichi , 467-8501 , Japan ; e-mail: eiji_okano@econ.nagoya-cu.ac.jp . 01 03 2018 10 2018 22 7
Publisher Copyright:
Copyright © Cambridge University Press 2018.
PY - 2018/10/1
Y1 - 2018/10/1
N2 - By developing a class of dynamic stochastic general equilibrium models with nominal rigidities and assuming a two-country currency union with sovereign risk, we show that there is not necessarily a trade-off between the prevention of default risk and stabilizing inflation. Under optimal monetary and fiscal policy, comprising a de facto inflation stabilization policy, the tax rate as an optimal fiscal policy tool plays an important role in stabilizing inflation, although not completely because of the distorted steady state. Changes in the tax rate to minimize welfare costs via stabilizing inflation then improve the fiscal surplus, and because of this and the incompletely stabilized inflation, the default rate does not increase as much.
AB - By developing a class of dynamic stochastic general equilibrium models with nominal rigidities and assuming a two-country currency union with sovereign risk, we show that there is not necessarily a trade-off between the prevention of default risk and stabilizing inflation. Under optimal monetary and fiscal policy, comprising a de facto inflation stabilization policy, the tax rate as an optimal fiscal policy tool plays an important role in stabilizing inflation, although not completely because of the distorted steady state. Changes in the tax rate to minimize welfare costs via stabilizing inflation then improve the fiscal surplus, and because of this and the incompletely stabilized inflation, the default rate does not increase as much.
KW - European Crisis
KW - Fiscal Theory of the Price Level
KW - Optimal Monetary Policy
KW - Sovereign Risk
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U2 - 10.1017/S1365100516000870
DO - 10.1017/S1365100516000870
M3 - Article
AN - SCOPUS:85042727659
SN - 1365-1005
VL - 22
SP - 1790
EP - 1807
JO - Macroeconomic Dynamics
JF - Macroeconomic Dynamics
IS - 7
ER -