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Two Naked Emperors? Concerns about the Stability and Growth Pact and Second Thoughts About Central Bank Independence

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  • Buiter, Willem H

Abstract

This 2003 Institute for Fiscal Studies Lecture addresses two sets of issues relevant to current and prospective future E(M)U members: the consequences of the Stability and Growth Pact for fiscal-financial sustainability and macroeconomic stability, and some risks associated with operational independence of the central bank. The relevance of the second issue is not restricted to E(M)U members. Poor communication, cooperation and coordination between the fiscal and monetary authorities can be costly in two contingencies. The first of these occurs when the central bank’s role as the lender of last resort needs to be backed up by the willingness of the Treasury to recapitalize the central bank, should the need arise. The second contingency occurs when unwanted deflation needs to be prevented or combated, but the central bank’s conventional monetary arsenal is exhausted. Friedman’s helicopter drop of money, a temporary tax cut or transfer payment increase financed through the issuance of base money will always stimulate demand provided it is not expected to be reversed, in present value terms, in the future. In most real-world institutional/legal settings the implementation of a helicopter drop of base money requires coordinated actions by the central bank and Treasury. Central bank independence is unlikely to survive if either or both of these contingencies occur, if there is an ineffective response by the fiscal and monetary authorities and if this is blamed on lack of communication, cooperation or coordination.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4001.

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Date of creation: Aug 2003
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Handle: RePEc:cpr:ceprdp:4001

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Keywords: central bank independence; deflation; fiscal rules; helicopter money drop; lender of last resort; stability and growth pact; zero bound;

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References

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  1. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  2. Hans-Werner Sinn, 2002. "The New Systems Competition," NBER Working Papers 8747, National Bureau of Economic Research, Inc.
  3. Willem H. Buiter & Clemens Grafe, 2004. "Patching up the Pact," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 12(1), pages 67-102, 03.
  4. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Working Paper 00-03, Federal Reserve Bank of Richmond.
  5. Rogoff, Kenneth, 1985. "Can international monetary policy cooperation be counterproductive?," Journal of International Economics, Elsevier, vol. 18(3-4), pages 199-217, May.
  6. Willem H. Buiter & Nikolaos Panigirtzoglou, 1999. "Liquidity Traps: How to Avoid Them and How to Escape Them," NBER Working Papers 7245, National Bureau of Economic Research, Inc.
  7. Samuelson, Paul A, 1994. "Facets of Balassa-Samuelson Thirty Years Later," Review of International Economics, Wiley Blackwell, vol. 2(3), pages 201-26, October.
  8. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  9. Christophe Chamley, 1984. "Optimal Taxation of Capital Income in Economies with Identical Private and Social Discount Rates," Cowles Foundation Discussion Papers 699, Cowles Foundation for Research in Economics, Yale University.
  10. Willem H. Buiter & Nikolaos Panigirtzoglou, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency: gesell's solution," Economic Journal, Royal Economic Society, vol. 113(490), pages 723-746, October.
  11. Chamley, Christophe, 1981. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 468-96, June.
  12. Charles Goodhart, 1999. "Recent Developments in Central Banking: Some Special Features of the Monetary Policy Committee and of the European System of Central Banks," FMG Special Papers sp118, Financial Markets Group.
  13. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
  14. Buiter, Willem H, 2003. "Deflation: Prevention and Cure," CEPR Discussion Papers 3869, C.E.P.R. Discussion Papers.
  15. Willem H. Buiter, 2003. "Ten Commandments for a Fiscal Rule in the E(M)U," Oxford Review of Economic Policy, Oxford University Press, vol. 19(1), pages 84-99.
  16. Padoa-Schioppa, Tommaso, 1999. "EMU and Banking Supervision," International Finance, Wiley Blackwell, vol. 2(2), pages 295-308, July.
  17. M. Fase, 2005. "On Economics and Religion," De Economist, Springer, vol. 153(1), pages 85-106, December.
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  1. > Political Economy > The Political Economy of the European Union
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Cited by:
  1. Willem H. Buiter, 2007. "Seigniorage," LSE Research Online Documents on Economics 19733, London School of Economics and Political Science, LSE Library.
  2. Willem H. Buiter, 2003. "Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap," NBER Working Papers 10163, National Bureau of Economic Research, Inc.
  3. Anna Schwartz, 2004. "Risks to the long-term stability of the euro," Atlantic Economic Journal, International Atlantic Economic Society, vol. 32(1), pages 1-10, March.

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