Fiscal Neglect in a Monetary Union


  • We would like to thank the editor and two anonymous referees, as well as seminar participants at the European Central Bank for their comments and suggestions. We also gratefully acknowledge the support by the Australian Research Council (DP0879638), and the Ministry of Education, Youth and Sports of the Czech Republic (MSM 4977751301).

Jan Libich, La Trobe University, School of Business, Melbourne, Victoria 3086, Australia. Email:


The Duchy of Grand Fenwick, having satisfied all requirements of Eurozone accession, recently became its newest member. As the small dukedom has discontinued its use of the Fenwick Pound, its independent central bank has had its tasks relegated to the monitoring of the twelve banks that exist there, and no longer the exercising of monetary policy. Before joining the Eurozone, the Duchy's central bank had a hierarchical mandate, targeting low inflation, and subject to that the stability of unemployment. With a recent groundswell of popular opinion against the ruler, Duchess Gloriana XII, her government has sought to placate its subjects with free dental care, an increased state pension and subsidised wine. It can do this, now, in relatively safe knowledge the European Central Bank will not punish the Duchy's fiscal recklessness with higher interest rates – unlike the Duchy's independent central bank in the past.