Distortionary Taxation and Central Bank Design in a Monetary Union

We consider a monetary union where distortionary taxation leads to the classical inflation bias in dis¬cretionary monetary policy. We show that a more generous welfare state requires a more conservative central bank. This result rationalizes the perception that the European Central Bank is more focused than the U.S. Federal Reserve on putting a lid on inflation but less worried about deflation. Besides, when an economic crisis increases the welfare state costs for countries in the periphery of the union, making the common central bank more conservative will improve welfare not only in the core countries but also in the periphery.