Interactions between monetary and fiscal policy under flexible exchange rates
Abstract
The potential importance of fiscal policy in influencing inflation has recently been highlighted, following Woodford (1995), under the heading of the âFiscal Theory of the Price Levelâ (FTPL). Applications of this theory to open economies operating under flexible exchange rates has suggested that, in contrast to the closed economy FTPL, insolvent fiscal policy may lead to indeterminacy of price levels and nominal exchange rates. In this paper, we relax the assumptions underpinning the FTPL by developing a two country open economy model, where each country has overlapping generations of non-Ricardian consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently. We examine the case where the two countries have independent monetary and fiscal policies. We show that the fiscal response required to ensure stability of the real debt stock, and allow each country to operate an âactiveâ inflation-targeting monetary policy is greater when consumers are not infinitely lived. One monetary authority can abandon its active targeting of inflation to stabilise the debt of another fiscal authority, and there is no requirement that these policy makers operate in the same economy. Finally, in a series of simulations we show that fiscal shocks have limited impact on output and inflation provided the fiscal authorities meet the (weak) requirements of fiscal solvency. However, when one or more monetary authority is forced to abandon its active targeting of inflation, then fiscal shocks have a much greater impact on both output and inflation.(This abstract was borrowed from another version of this item.)
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Bibliographic Info
Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.
Volume (Year): 32 (2008)
Issue (Month): 9 (September)
Pages: 2854-2882
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Web page: http://www.elsevier.com/locate/jedc
Related research
Keywords:Other versions of this item:
- Leith, Campbell & Simon Wren-Lewis, 2003. "Interactions Between Monetary and Fiscal Policy Under Flexible Exchange Rates," Royal Economic Society Annual Conference 2003 134, Royal Economic Society.
- Campbell Leith & Simon Wren-Lewis, . "Interactions Between Monetary and Fiscal Policy under Flexible Exchange Rates," Working Papers 2002_11, Business School - Economics, University of Glasgow.
- E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Herings P. Jean-Jacques & Peeters Ronald & Yang Michael S., 2009. "Piracy on the internet: Accommodate it or fight it? A dynamic approach," Research Memoranda 034, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization.
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- Mikek, Peter, 2008. "Alternative monetary policies and fiscal regime in new EU members," Economic Systems, Elsevier, vol. 32(4), pages 335-353, December.
- Campbell Leith & Simon Wren-Lewis, 2002.
"Taylor Rules in the Open Economy,"
Discussion Papers
0203, Exeter University, Department of Economics.
- Leith, Campbell & Wren-Lewis, Simon, 2009. "Taylor rules in the open economy," European Economic Review, Elsevier, vol. 53(8), pages 971-995, November.
- Campbell Leith & Simon Wren-Lewis, 2002. "Taylor Rules in the Open Economy," Working Papers 2002_14, Business School - Economics, University of Glasgow.
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