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Five-Equation Macroeconomics: A Simple View of the Interactions Between Fiscal Policy and Monetary Policy

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  • Kirsanova, Tatiana
  • Stehn, Sven Jari
  • Vines, David

Abstract

This paper studies the interactions of fiscal and monetary policy when they stabilise a single economy against shocks in a dynamic setting. We assume that fiscal and monetary policies both stabilise the economy only by causing changes to aggregate demand. Our findings are as follows. If the both policymakers are benevolent, then the best outcome is achieved when the fiscal authority allows monetary policy to perform nearly all of the burden of stabilising the economy. If the monetary authorities are benevolent, but the fiscal authorities have distorted objectives, then a Nash equilibrium will result in large welfare losses: unilateral efforts by each authority to stabilise the economy will result in a rapid accumulation of public debt. However, if the monetary authorities are benevolent and the fiscal authorities have distorted objectives, but there is a regime of fiscal leadership, then the outcome will be very nearly as good as it is in the regime in which both policymakers are benevolent.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5464.

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Date of creation: Jan 2006
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Handle: RePEc:cpr:ceprdp:5464

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Keywords: fiscal policy; macroeconomic stabilisation; monetary policy;

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