Anchors Away: How Fiscal Policy Can Undermine "Good" Monetary Policy
AbstractSlow moving demographics are aging populations around the world and pushing many countries into an extended period of heightened fiscal stress. In some countries, taxes alone cannot or likely will not fully fund projected pension and health care expenditures. If economic agents place sufficient probability on the economy hitting its ”fiscal limit” at some point in the future, after which further tax revenues are not forthcoming, it may no longer be possible for “good” monetary policy—behavior that obeys the Taylor principle—to control inflation or anchor inflation expectations. In the period leading up to the fiscal limit, the more aggressively that monetary policy leans against inflationary winds, the more expected inflation becomes unhinged from the inflation target. Problems confronting monetary policy are exacerbated when policy institutions leave fiscal objectives and targets unspecified and, therefore, fiscal expectations unanchored. In light of this theory, the paper contrasts monetary-fiscal policy frameworks in the United States and Chile.
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Bibliographic InfoPaper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 580.
Date of creation: May 2010
Date of revision:
Other versions of this item:
- Eric M. Leeper, 2009. "Anchors Away: How Fiscal Policy Can Undermine “Good” Monetary Policy," Caepr Working Papers 2009-021, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
- NEP-AGE-2011-04-23 (Economics of Ageing)
- NEP-ALL-2011-04-23 (All new papers)
- NEP-CBA-2011-04-23 (Central Banking)
- NEP-MAC-2011-04-23 (Macroeconomics)
- NEP-MON-2011-04-23 (Monetary Economics)
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