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The adoption of a single currency in Europe has introduced an asymmetry in the level of monetary and fiscal governance. The monetary instrument is given to a central supra-national authority with a view to safeguarding areawide price stability, whereas the fiscal instrument is still within the hands of individual governments. Decisions on the management of the monetary instrument are thus taken at the EMU (European Economic and Monetary Union) level, whereas the use of the fiscal instrument is decided separately at the level of the nation states. The merits of this institutional arrangement in terms of helping achieve price stability have been rigorously analysed in the literature and agreed upon among EMU policy makers. What is less obvious, and perhaps more uncertain in the future however (especially in view of further enlargement), is the role that the fiscal instrument will acquire in this asymmetric set-up. The argument put forward in the literature is that in the absence of a national monetary instrument, governments are more likely to resort to a greater than otherwise use of their fiscal instrument. What will that mean for macroeconomic stability in general and for prices more specifically? It is often quoted that excessive use of the fiscal instrument can jeopardise price stability. And the question that arises as a result is whether European countries are more likely to use their fiscal instrument now than in the past, and if they are, whether this will make the European Central Bank's objective of price stability more difficult to attain. [ABSTRACT FROM AUTHOR]

When individuals are risk adverse, they dislike volatility in consumption. In an environment where economic fluctuations are driven by exogenous real shocks, governments try to prevent these exogenous real shocks from inducing consumption volatility. Taking the process that determines these exogenous fluctuations as given, there are two methods through which the government can intervene and prevent excessive consumption volatility. They can use the various tools of government, like monetary policy or government consumption, to smooth aggregate demand and aggregate output in the face of these exogenous shocks. Similarly they can allow fluctuations in output, but use fiscal policy through direct taxes and transfers to smooth any consumption fluctuations. It should be clear from the title that this paper will focus on the latter method. In a currency union like the euro zone, individual national governments ceded their national monetary policies to the European Central Bank. Thus individual governments in the euro zone no longer have monetary policy as a tool to prevent country-specific real shocks from driving fluctuations in country-specific output. As will be clear in a later section, this paper will not model the role of government consumption in smoothing output fluctuations (see Fatás and Mihov 1999, for a discussion on the output stabilizing role of government spending). Instead this paper will focus on the role of a government tax and transfer scheme in smoothing consumption fluctuations given fluctuations in output. [ABSTRACT FROM AUTHOR]

This paper develops an endogenous coalition formation framework suitable for studying a design of international macroeconomic policy coordination between an arbitrary number of countries and monetary authorities in the presence of (possibly multiple) monetary unions. In analyzing the feasibility of policy cooperation, we follow the approach proposed by the recent literature on the non-cooperative theory of coalition formation, which includes Bloch (1995, 1996), Yi (1997), Ray and Vohra (1997, 1999), Finus (2001) and Finus and Rundshagen (2001, 2003). These models share the common framework of a two-stage structure. In the first stage, coalitions are formed. In the second stage of the game (the stabilization phase), assuming all coalition structures as given, the model is solved by methods of linear quadratic differential games. [ABSTRACT FROM AUTHOR]

Problems of macroeconomic stabilization policies have been analyzed by means of optimal control theory since the early seventies [see, for example, Kendrick (1981)]. However, with the emergence of the New Classical Macroeconomics, this theoretical framework has been increasingly questioned. In particular, Kydland's and Prescott's (1977) claim that government's stabilization policies derived by optimum control methods might be time-inconsistent when private-sector agents have rational expectations of policy-makers' behaviour has been regarded as a serious argument against the use of optimum control theory in macroeconomics, although the real-world importance of time-inconsistent behaviour is still controversial. [For an early theoretical critique, see Hughes Hallett (1986a); for empirical analyses, Ireland (1999), Boschen and Weise (2004), among others.] Later research on time-inconsistency indicates that dynamic game theory is a more appropriate tool for analyzing stabilization policy problems because more than one decision-maker has to be considered explicitly. Therefore over the last three decades, a large number of studies of macroeconomic stabilization policies (as well as of other areas in economics) have made use of the concepts and results of the theory of dynamic games. [ABSTRACT FROM AUTHOR]

One of the most pervasive trends in modern macroeconomics is the use of microeconomic theory to derive the behavioural equations of a macroeconomic model. This is frequently accomplished by the invocation of a single "representative agent", whose own optimising decisions are then scaled up to represent the aggregate behaviour of all consumers in the economy. On the positive side, these strong assumptions permit the marriage of micro and macroeconomic analysis, with the behaviour of the economy at aggregate level directly explicable in terms of individual optimising behaviour. In addition, the preferences of the representative agent are often used to rank different policy outcomes. In the words of Woodford (2001): "An important advantage of using a model founded on private-sector optimisation to analyze the consequences of alternative policy rules is that there is a natural welfare criterion in the context of such a model, provided by the preferences of private agents that are displayed in the structural relations that determine the effects of alternative policies." This usage of microfounded models to provide a welfare-metric evaluation marks an important new step in quantitative economic policy. Previously, the task of economic theory was typically confined to the positive role of quantifying the likely effects of various policies. The normative task of ranking policy outcomes, or of specifying the "optimal policy", was left to the policymaker, who would simply choose according to his own volition from the menu of possible outcomes given by the positive economic analysis. [ABSTRACT FROM AUTHOR]

The purpose of this paper is to honour Andrew Hughes Hallett. We think that a convenient way to do this is to outline the evolution of the theory of economic policy, in which he has played such a decisive role, from the classical contributions of Frisch, Hansen, Tinbergen and Theil to the present day when a sort of "new" theory of economic policy seems to have emerged from the ashes of the old one. [ABSTRACT FROM AUTHOR]