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Welfare Improving Coordination Of Fiscal And Monetary Policy

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  • Andrew Hughes Hallet
  • Jan Libich

    ()

  • Petr Stehlik

Abstract

The paper considers a simple model in which monetary and fi?scal policies are formally independent, but still interdependent - through their spillovers onto the macroeconomic targets to which they are not primarilly assigned. It shows that the average equilibrium levels of inflation, deficit, debt, and output depend on the two policies' (i) potency (elas- ticity of output with respect to the policy instruments); (ii) ambition (the level of their output target); and (iii) conservatism (inflation vs output volatility aversion). However, it is the relative degrees of these characteristics that matter, rather than the absolute degrees for each policy. Therefore, and as expected, coordination of monetary and ?fiscal policy is found to be superior to non-cooperative Nash behaviour for both policymakers. Interestingly though, it is coordination in terms of the policies' ambition, rather than conservatism, that is essential. That is a new result. Furthermore, ambition-coordination can be welfare improving even if the policymakers' objectives are idiosyncratic, and/or even their coordinated output targets differ from the socially optimal one.

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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2008-04.

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Length: 22 pages
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:een:camaaa:2008-04

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References

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  1. Hughes Hallett, Andrew & Libich, Jan & Stehlík, Petr, 2009. "Rogoff revisited: The conservative central banker proposition under active fiscal policies," Economics Letters, Elsevier, Elsevier, vol. 104(3), pages 140-143, September.
  2. Demertzis, Maria & Hughes Hallett, Andrew, 1999. "An Independent Central Bank Faced With Elected Governments," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2219, C.E.P.R. Discussion Papers.
  3. Jan Libich & Andrew Hughes Hallett & Petr Stehlik, 2007. "Monetary And Fiscal Policy Interaction With Various Degrees And Types Of Commitment," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2007-21, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Andrew Hallett & Jan Libich, 2012. "Explicit inflation targets and central bank independence: friends or foes?," Economic Change and Restructuring, Springer, Springer, vol. 45(4), pages 271-297, November.
  5. Aarle, B. van & Engwerda, J.C. & Plasmans, J.E.J., 2001. "Monetary and Fiscal Policy Interaction in the EMU: A Dynamic Game Approach," Open Access publications from Tilburg University, Tilburg University urn:nbn:nl:ui:12-88307, Tilburg University.
  6. Benhabib, Jess & Eusepi, Stefano, 2005. "The design of monetary and fiscal policy: A global perspective," Journal of Economic Theory, Elsevier, Elsevier, vol. 123(1), pages 40-73, July.
  7. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  8. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall.
  9. Hughes Hallett, A J, 1986. "Autonomy and the Choice of Policy in Asymmetrically Dependent Economies: An Investigation of the Gains from International Policy Co-ordination," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 516-44, November.
  10. 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, Springer, vol. 18(5), pages 559-576, November.
  11. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  12. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, American Economic Association, vol. 91(4), pages 964-985, September.
  13. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, American Economic Association, vol. 82(1), pages 273-86, March.
  14. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, American Economic Association, vol. 85(1), pages 150-67, March.
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Cited by:
  1. repec:ltr:wpaper:2009.02 is not listed on IDEAS
  2. Andrew Hughes Hallett & Jan Libich & Petr Stehlík, 2011. "Macroprudential Policies and Financial Stability," The Economic Record, The Economic Society of Australia, The Economic Society of Australia, vol. 87(277), pages 318-334, 06.
  3. Daly, Hounaida & Smida, Mounir, 2013. "Interaction entre politique monétaire et politique budgétaire:Cas de la Grèce
    [Fiscal and Monetary Policy Interactions : The Greece Case]
    ," MPRA Paper 45931, University Library of Munich, Germany.
  4. Andrew Hughes Hallett & Jan Libich & Petr Stehlik, 2007. "Rogoff Revisited: The Conservative Central Banker Proposition Under Active Fiscal Policies," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2007-20, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  5. Daly, Hounaida & Smida, Mounir, 2013. "La coordination des politiques monétaire et budgétaire: Aperçu théorique
    [Coordination of monetary and fiscal policies: Theoretical Overview]
    ," MPRA Paper 48020, University Library of Munich, Germany.
  6. Muhammad Ali Nasir & Alaa M. Soliman, 2014. "Aspects of Macroeconomic Policy Combinations and Their Effects on Financial Markets," Economic Issues Journal Articles, Economic Issues, Economic Issues, vol. 19(1), pages 95-118, March.

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