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Monetary Policy, Fiscal Policies, and Labour Markets: Macroeconomic Policymaking in the EMU.

Monetary Policy, Fiscal Policies, and Labour Markets: Macroeconomic Policymaking in the EMU Roel Beetsma, Carlo Favero, Alessandro Missale, Anton Muscatelli, Piergiovanna Natale and Patrizio Tirelli (eds) Cambridge University Press: Cambridge, UK, and New York, 2004, xvi, 373pp.

The contributions to this volume were first presented at the University of Milano-Bicocca conference in September 2001, though their freshness gives the impression of having been conceived much more recently.

In the monetary section of the book, Stephen Cecchetti gives an overall favourable assessment of the European Central Bank's performance, although he faults its lack of transparency and its 'two-pillar' strategy that he contends unnecessarily emphasises money alongside a range of indicators of future prices. Carlo Favero's contribution evaluates the ECB's use of the percentage change in the Harmonised Index of Consumer Prices as its primary measure of EMU inflation targeting in light of the recent literature on New Keynesian inflation dynamics. In another paper on EMU monetary policy, Pierpaolo Benigno and J. David Lopez-Salido follow up on their own earlier work extending the New Keynesian empirical methodology to five European nations accounting for nearly 90 per cent of EMU GDP.

In reaction to their results indicating that backward-looking price-setting behaviour is more pronounced in Spain, Italy, the Netherlands, and France, whereas forward-looking behaviour is more important in Germany, in this paper Benigno and Lopez-Salido construct a two-country dynamic-general-equilibrium (DGE) framework in which both forward- and backward-looking behaviour are important in one nation while only the former predominates in the other. A DGE analysis allows for behavioural heterogeneities across countries. However, their very smooth measure of inflation and very specific proxy for aggregate marginal cost implies implausibly that firms in Spain, Italy, the Netherlands, and France keep their prices unchanged for an average of at least 2 years! In the final paper of the monetary section, Fabio Bagliano, Roberto Golinelli, and Claudio Morana, employs a common trends model in an effort to estimate core inflation for the EMU nations from 1978 to 2001. They conclude that transitory shocks have short-lived effects on inflation, which leads them to suggest that deviations of core inflation from the ECB's target convey appropriate policy signals.

In the fiscal policy section of the book, Roel Beetsma and Xavier Debrun have produced an outstanding survey of the preceding literature's conclusions concerning credibility, stabilisation, and institutional issues relating to the conduct of fiscal policy and its interaction with monetary policy in an international context. Giuseppe De Arcangelis and Serena Lamartina pursue an empirical analysis aimed at determining the general fiscal stances of France, Germany, Italy, and the United States. Does spending cause taxes or the reverse? They conclude that although German and US government spending on wages and transfers are more important than other fiscal spending components, in France and Italy these forms of government expenditures induce variations in other fiscal variables, thereby exposing these nations to broader fiscal pressures.

In the last empirical paper in this section, Anton Muscatelli, Patrizio Tirelli, and Carmine Trecroci utilise vector autogregressions to evaluate the extent of monetary and fiscal policy interactions in the same four countries plus the United Kingdom. They conclude that the standard monetary transmission mechanism does not appear to be strongly affected when fiscal policies are taken into account, that fiscal policy responses to inflation shocks appear to be muted, and that monetary-fiscal interactions exhibit considerable asymmetry and instability.

The section on labour markets opens with an exhaustive review by Alex Cukierman of the literature on the interplay between labour market institutions and monetary policy both outside and inside monetary unions. Anyone interested in this general area of inquiry would be well advised to read this paper. In the closing remarks to his paper, Alex Cukierman touches on an issue that a reading of this book, together with much of the related literature, reveals to be crucial for contemporary policy analysis: the relative timing of monetary policy and nominal adjustments in the real economy. As Cukierman points out, policy analyses using models based on price stickiness, which encompass most new open-economic macrotheories, assume that prices are set before monetary policy decisions take place and fail to adjust simply because of the assumed price stickiness, presumably due to menu costs. In contrast, in models in which wage stickiness is the main source of nominal rigidities, as traditionally assumed in Mundell-Fleming- and Barro-Gordon-style approaches, monetary policy choices take place before prices are set, and firms' choices not to adjust prices fully are profitmaximising responses. In this latter class of models, therefore, adding output-price stickiness to input-price stickiness arising from nominal wage contracts provides little additional of import for the policy process. Nevertheless, the two classes of models rely on very different microeconomic foundations and imply potentially very different rules of the game for policymakers. Cukierman's incisive exposition of this point, together with the juxtaposition of contributions in this volume that employ both types of approaches, highlight the importance of reaching a consensus on the key source of nominal rigidities in real-world economies. Common ground must be found on this fundamental issue before any degree of consensus can be attained regarding the fundamental monetary policy, fiscal policy, and labour market issues faced by current and prospective members of the EMU.

Andrew Hughes Hallett and Svend Hougaard Jensen's concluding contribution provides a fascinating analysis of models comprised of both countries already in a monetary union and also prospective member nations. The existing EMU nations might be pleased to admit the northern-tier nations (Sweden, Denmark, and the United Kingdom) as long as the current membership does not have to reform, yet the northern-tier non-members have little incentive to join the EMU without such reforms being undertaken. At the same time, however, Central or Eastern European nations have considerable incentive to join the EMU, but the current EMU countries have little to gain from admitting them.

Besides these papers, the volume includes theoretical articles by Luca Lambertini and Riccardo Rovelli, by Luca Onorante, by Campbell Leith and Simon Wren-Lewis, and by Lilia Cavallari.

David VanHoose

Baylor University, Waco, TX, USA
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Author:VanHoose, David
Publication:Comparative Economic Studies
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Date:Sep 1, 2005
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