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Monetary Exit Strategy and Fiscal Spillovers

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  • Jan Libich

    ()

  • Dat Thanh Nguyen
  • Petr Stehlík

Abstract

The paper models strategic monetary-fiscal interactions in the aftermath of the global financial crisis - in a single country as well as a monetary union. It depicts both the short- term (stabilization) perspective and the long-term (sustainability) perspective, and the link between them. This is done in a game theoretic framework that allows for revisions of actions, deterministic or stochastic. In addition, we consider incomplete information about economic conditions, and different types of government. We find that, under ambitious fiscal policies, a legislated long-term monetary commitment may: (i) reduce the risk of a double-dip recession and deflation in the short-term, and at the same time (ii) facilitate the 'exit strategy' of monetary policy, ie prevent sub-optimally high future inflation caused by fiscal spillovers. Our analysis thus implies that an explicit numerical target for average inflation may play the role of a monetary 'credibility insurance' over all phases of the business cycle, and is beneficial especially in countries facing fiscal stress.

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File URL: http://cama.crawford.anu.edu.au/pdf/working-papers/2011/042011.pdf
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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 2011-04.

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Length: 18 pages
Date of creation: Feb 2011
Date of revision:
Handle: RePEc:een:camaaa:2011-04

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  1. Adam, Klaus & Billi, Roberto M., 2008. "Monetary conservatism and fiscal policy," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1376-1388, November.
  2. 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.
  3. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco.
  4. Jon Faust & Lars E.O. Svensson, 1998. "Transparency and credibility: monetary policy with unobservable goals," International Finance Discussion Papers 605, Board of Governors of the Federal Reserve System (U.S.).
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  6. Michal Franta & Jan Libich & Petr Stehlík, 2011. "The Big Picture of Monetary–Fiscal Interactions," Economic Papers, The Economic Society of Australia, vol. 30(1), pages 6-14, 03.
  7. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  8. WILLIAM A. BRANCH & TROY DAVIG & BRUCE McGOUGH, 2008. "Monetary-Fiscal Policy Interactions under Implementable Monetary Policy Rules," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 1095-1102, 08.
  9. 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.
  10. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, I: Overview and Quantity Competition with Large Fixed Costs," Econometrica, Econometric Society, vol. 56(3), pages 549-69, May.
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  12. Alesina, Alberto & Tabellini, Guido, 1987. "Rules and Discretion with Noncoordinated Monetary and Fiscal Policies," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 619-30, October.
  13. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  14. Libich, Jan & Stehlík, Petr, 2010. "Incorporating rigidity and commitment in the timing structure of macroeconomic games," Economic Modelling, Elsevier, vol. 27(3), pages 767-781, May.
  15. Ernst Schaumburg & Andrea Tambalotti, 2003. "An investigation of the gains from commitment in monetary policy," Staff Reports 171, Federal Reserve Bank of New York.
  16. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  17. repec:ltr:wpaper:2010.01 is not listed on IDEAS
  18. Eric M. Leeper, 2010. "Monetary science, fiscal alchemy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 361-434.
  19. Suren Basov & Jan Libich & Petr Stehlík, 2010. "Stochastic Timing, Uniqueness, and Efficiency in Games," Working Papers 2010.01, School of Economics, La Trobe University.
  20. William D. Nordhaus, 1994. "Policy games: Coordination and Independece in Monetary and Fiscal Policies," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 139-216.
  21. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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Cited by:
  1. Eddie Gerba & Klemens Hauzenberger, 2013. "Estimating US Fiscal and Monetary Interactions in a Time Varying VAR," Studies in Economics 1303, Department of Economics, University of Kent.
  2. Michal Franta & Jan Libich & Petr Stehlík, 2012. "Tracking Monetary-Fiscal Interactions across Time and Space," CAMA Working Papers 2012-40, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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