On the Efficiency of Monetary and Fiscal Policy in Open Economies

Chan Wang

and

Heng-fu Zou

This paper investigates the efficiency of monetary and fiscal policy in a two-country general equilibrium model with monopolistic competition and wage stickiness. When monopoly distortions are completely eliminated, we find that under some conditions, stochastic government spending can affect the efficiency of global monetary policy rules that replicate the real allocations under flexible wages. When stochastic government spending is present, unlike Obstfeld and Rogoff (2000), we find that, when the above-mentioned conditions are satisfied, the monopoly distortions can also affect the efficiency of global monetary policy rules that replicate the real allocations under flexible wages. The combination of proportional subsidy policies used to completely eliminate monopoly distortions and the monetary policy rules replicating the real allocations under flexible wages, contrary to Obstfeld and Rogoff (2000), can not achieve utility level under competitive equilibrium in our settings. Fiscal policy is found to be unable to replicate the real allocations under flexible wages.