This paper aims at investigating the coordination of fiscal policies within the European Monetary Union. In a two-country model of monetary union under a flexible exchange rate with the rest of the world and perfect capital mobility, increased public spending would be favourable to employment in the originating country, but would harm the other one via exports crowding out. It is shown that, despite sanctions for spendthrift governments, in a one shot game discretion is the dominant strategy and entails a Pareto inefficient outcome , with no employment gains but with excessive public deficits. The sanction is thus ineffective. However, in a game where policymakers have a multi-period decision horizon, the cooperative outcome may emerge spontaneously, even in the absence of a supranational coercion scheme. The sanction is thus useless.
VRANCEANU, R. and WARIN, T. (1998). Une étude théorique de la coordination budgétaire en union monétaire. ESSEC Business School.