Macroeconomic Policy Interaction under EMU: A Dynamic Game Approach

In this paper we study macroeconomic stabilization in the Economic and Monetary Union (EMU) using a dynamic game approach. With the aid of a stylized macroeconomic model, this paper analyzes the transmission and interaction of national fiscal policies and monetary policy of the European Central Bank (ECB) in the EMU. A special focus is on the effects of labor market institutions in the participating countries and of the introduction of fiscal stringency criteria like those imposed in the Stability and Growth Pact. Keywords: Macroeconomic stabilization, EMU, Linear Quadratic differential games, Riccati equations JEL Classification: C73, E17, E52, E61,F33, F42 2 Introduction The European Union (EU) countries have started the Economic and Monetary Union (EMU) on January 1, 1999. With the EMU, eleven EU countries replace their national currencies and national monetary policy autonomy by a common currency, the Euro, and a common monetary policy that is designed and implemented by the E..