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Monetary and Fiscal Policy Interaction: What is the Role of the Transaction Cost of the Tax System in Stabilisation Policies?

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  • Panagiotis Chronis

    ()
    (Bank of Greece)

  • Aspassia Strantzalou

    (Ministry of Employment and Social Protection, Greece)

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    Abstract

    In the theory of monetary and fiscal policy interaction, the assumption of Ricardian households isolates the determinants of fiscal policy instrument from the price stabilization policies carried out by the central bank. One of the main implications of the above mentioned Ricardian assumption is that the fiscal policy does not have any distortionary effect for the economy, i.e. it does not affect the behaviour of the households, supporting that way the fiscal policy’s neutrality. The argument for this view comes if one assumes that fiscal policy has a distortionary effect on the behaviour of the agents. We relax the above non distortionary assumption by assuming that the imposition of the taxes is consistent with a transaction cost of the tax system that underlies the state - tax payer interaction. In this way we develop a channel through which the stability of prices carried out by the independent central bank is, within optimality, also a function of the fiscal policy determinants (the transaction cost, the tax rates and the debt level). The analysis is carried out in a framework of a monetary union, with two different countries. Within this framework, the effectiveness of a numerical fiscal rule is also examined.

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    Bibliographic Info

    Paper provided by Bank of Greece in its series Working Papers with number 71.

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    Length: 48 pages
    Date of creation: May 2008
    Date of revision:
    Handle: RePEc:bog:wpaper:71

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    Related research

    Keywords: Monetary and fiscal policy interactions; Transaction cost of the tax system; Probability of re-election; Stability and growth pact;

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    Cited by:
    1. Alexander Apostolides, 2008. "How Similar to South-Eastern Europe were the Islands of Cyprus and Malta in terms of Agricultural Output and Credit? Evidence during the Interwar Period," Working Papers 80, Bank of Greece.
    2. Milan Sojic & Ljiljana Djurdjevic, 2008. "Monetary Policy Objectives and Istruments used by the Privileged National Bank of the Kingdom of Serbia (1884 - 1914)," Working Papers 87, Bank of Greece.

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