When the Taylor principle isinsufficient

Abstract

This paper derives restrictions on monetary and fiscal policies for determinate equilibria in a two-country monetary union with autarkic members. It finds that a central bank following the Taylor principle may not be suffcient for determinacy unless accompanied by one 'active' fiscal authority in the sense of Leeper (1991). Alternatively, both fiscal authorities can be 'active' while the central bank abandons the Taylor principle. The two determinate equilibria have significantly different implications for the transmission of fiscal and monetary shocks and for the fiscal theory of the price level in a monetary union.