Monetary and Fiscal Policy Interactions: The Role of the Quality of Institutions in a Dynamic Environment
AbstractThis paper analyses the interaction between fiscal and monetary policy using the original Barro and Gordon (1983) model extended to include fiscal policy, dynamics and the level of institutional quality, measured as bureaucratic corruption. It is found that delegating monetary policy to an independent central bank (i.e. not fiscally dominated) the second best solution of the model is achievable only if there is no bureaucratic corruption. Otherwise, when institutional quality is not optimal, unless a less conservative than the government, regarding output considerations, independent central bank is delegated, the second best is not restored. The government has the incentive to increase debt strategically in an attempt to increase second period inflation. This result is augmented by the quality of institutions and poses difficulties on the achievement of both price stability and a balanced debt process. Quality of institutions, hence, can provide an explanation for the poorer inflation performance, due to debt boosts, of countries with lower institutional quality despite the introduction of central bank independence.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0607.
Date of creation: Jul 2006
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Find related papers by JEL classification:
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-07-28 (All new papers)
- NEP-CBA-2006-07-28 (Central Banking)
- NEP-MAC-2006-07-28 (Macroeconomics)
- NEP-MON-2006-07-28 (Monetary Economics)
- NEP-PBE-2006-07-28 (Public Economics)
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