Advanced Search
MyIDEAS: Login to save this paper or follow this series

Monetary and Fiscal Policy Interaction with Various Degrees and Types of Commitment

Contents:

Author Info

  • Hughes Hallett, Andrew
  • Libich, Jan
  • Stehlík, Petr

Abstract

Monetary and Fiscal policies interact in many ways. Recently the stance of fiscal policy in a number of countries has raised concerns about the risks for the outcomes of monetary policy. This paper first shows that these concerns are justified since, under ambitious fiscal policy makers, inflation bias and lack of monetary policy credibility may obtain in equilibrium even if the central banker is fully independent, patient and responsible. To reach a solution, the paper proposes an asynchronous game framework that generalises the standard commitment analysis. It allows concurrent and partial commitment; both policies may be committed at the same time for varying degrees or different periods. It is demonstrated that these undesirable outcomes can be prevented if monetary commitment is sufficiently strong relative to fiscal commitment. Interestingly, monetary commitment can not only resist fiscal pressure, but also discipline an ambitious fiscal policy maker to achieve socially desirable outcomes for both policies. We extend the setting to the European monetary union case with a common central bank and many fiscal policy makers, to show that these results carry over. The implication therefore is: by explicitly committing to a long run inflation target, the central bank can not only ensure its credibility, but also indirectly induce more disciplined fiscal policies. The paper shows that these predictions are broadly supported empirically.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.cepr.org/pubs/dps/DP6586.asp
Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6586.

as in new window
Length:
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:cpr:ceprdp:6586

Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820

Order Information:
Email:

Related research

Keywords: asynchronous moves; Battle of sexes; commitment; Game of chicken; inflation targeting; monetary-fiscal interactions;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Jon Faust & Lars E. O. Svensson, 1998. "Transparency and Credibility: Monetary Policy with Unobservable Goals," NBER Working Papers 6452, National Bureau of Economic Research, Inc.
  2. Ricardo Reis, 2004. "Inattentive Consumers," Working Papers 135, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
  3. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  4. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  5. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
  6. Petra M. Geraats, 2002. "Central Bank Transparency," Economic Journal, Royal Economic Society, vol. 112(483), pages 532-565, November.
  7. Jan Libich & Petr Stehlik, 2007. "Incorporating Rigidity In The Timing Structure Of Macroeconomic Games," CAMA Working Papers 2007-10, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  8. Eric Maskin & Jean Tirole, 2010. "A Theory of Dynamic Oligopoly, 1: Overview and Quantity Competition with Large Fixed Costs," Levine's Working Paper Archive 397, David K. Levine.
  9. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  10. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  11. Bhattacharya, Joydeep & Haslag, Joseph, 1999. "Monetary Policy Arithmetic: Some Recent Contributions," Staff General Research Papers 10388, Iowa State University, Department of Economics.
  12. Richard C. Barnett, 2001. "Inflation, taxes, and the coordination of monetary and fiscal policy by use of a game of chicken," Canadian Journal of Economics, Canadian Economics Association, vol. 34(1), pages 82-99, February.
  13. Eric Maskin & Jean Tirole, 1997. "Markov Perfect Equilibrium, I: Observable Actions," Harvard Institute of Economic Research Working Papers 1799, Harvard - Institute of Economic Research.
  14. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  15. In-Koo Cho & Akihiko Matsui, 2005. "Time Consistency In Alternating-Move Policy Games," The Japanese Economic Review, Japanese Economic Association, vol. 56(3), pages 273-294.
  16. Tobin, James, 1981. "Money and Finance in the Macro-Economic Process," Nobel Prize in Economics documents 1981-1, Nobel Prize Committee.
  17. Persson, Mats & Persson, Torsten & Svenssor, Lars E. O., 2005. "Time Consistency of Fiscal and Monetary Policy: A Solution," Papers 09-03-2005, Princeton University, Research Program in Political Economy.
  18. Andrew Hughes Hallett & Diana N. Weymark, 2002. "Independence Before Conservatism: Transparency, Politics, and Central Bank Design," Vanderbilt University Department of Economics Working Papers 0202, Vanderbilt University Department of Economics.
  19. Jan Libich, 2006. "Inflexibility Of Inflation Targeting Revisited: Modeling The "Anchoring"Effect," CAMA Working Papers 2006-02, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  20. Eijffinger, S.C.W. & Geraats, P., 2006. "How transparent are central banks?," Open Access publications from Tilburg University urn:nbn:nl:ui:12-172467, Tilburg University.
  21. Roger Lagunoff & Akihiko Matsu, . ""Asynchronous Choice in Repeated Coordination Games''," CARESS Working Papres 96-10, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  22. Andrew Hallett & Jan Libich, 2012. "Explicit inflation targets and central bank independence: friends or foes?," Economic Change and Restructuring, Springer, vol. 45(4), pages 271-297, November.
  23. Jan Libich, 2006. "An Explicit Inflation Target As A Commitment Device," CAMA Working Papers 2006-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  24. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  25. Benjamin M. Friedman, 2004. "Why the Federal Reserve Should Not Adopt Inflation Targeting," International Finance, Wiley Blackwell, vol. 7(1), pages 129-136, 03.
  26. Avinash Dixit & Luisa Lambertini, 2003. "Interactions of Commitment and Discretion in Monetary and Fiscal Policies," American Economic Review, American Economic Association, vol. 93(5), pages 1522-1542, December.
  27. Paul Masson & Catherine Pattillo, 2002. "Monetary Union in West Africa: An Agency of Restraint for Fiscal Policies?," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 11(3), pages 387-412, September.
  28. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  29. Andrew Hughes Hallett & Jan Libich, 2007. "Fiscal-monetary Interactions: The Effect of Fiscal Restraint and Public Monitoring on Central Bank Credibility," Open Economies Review, Springer, vol. 18(5), pages 559-576, November.
  30. Nordhaus, William D, 1975. "The Political Business Cycle," Review of Economic Studies, Wiley Blackwell, vol. 42(2), pages 169-90, April.
  31. Robert A. Mundell, 1962. "The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability," IMF Staff Papers, Palgrave Macmillan, vol. 9(1), pages 70-79, March.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Andrew Hughes Hallett & Jan Libich & Petr Stehlik, 2007. "Rogoff Revisited: The Conservative Central Banker Proposition Under Active Fiscal Policies," CAMA Working Papers 2007-20, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Andrew Hughes Hallett, 2008. "Sustainable fiscal policies and budgetary risk under alternative monetary policy arrangements," Economic Change and Restructuring, Springer, vol. 41(1), pages 1-28, March.
  3. Andrew Hughes Hallett & Jan Libich & Petr Stehlik, 2009. "Financial Instability Prevention," CAMA Working Papers 2009-14, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Jan Libich & Petr Stehlik, 2008. "Fiscal Rigidity In A Monetary Union: The Calvo Timing And Beyond," CAMA Working Papers 2008-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  5. Andrew Hughes Hallet & Jan Libich & Petr Stehlik, 2008. "Welfare Improving Coordination Of Fiscal And Monetary Policy," CAMA Working Papers 2008-04, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. Dumitriu, Ramona & Stefanescu, Razvan, 2013. "Provocările politicii monetare
    [Monetary policy challenges]
    ," MPRA Paper 50261, University Library of Munich, Germany, revised 28 Sep 2013.
  7. Andrew Hughes Hallett, 2008. "Debt targets and fiscal sustainability in an era of monetary independence," International Economics and Economic Policy, Springer, vol. 5(1), pages 165-187, July.
  8. Andrew Hughes Hallett, 2008. "Coordination without Explicit Cooperation: Monetary-Fiscal Interactions in an Era of Demographic Change," European Economy - Economic Papers 305, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:6586. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.