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

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  • Tatiana Kirsanova

    (Department of Economics, University of Exeter)

  • Sven Jari Stehn

    (Brasenose College, University of Oxford)

  • David Vines

    (Economics Department and Balliol College, University of Oxford, Australian National University and CEPR)

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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File URL: http://people.exeter.ac.uk/cc371/RePEc/dpapers/DP0610.pdf
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Bibliographic Info

Paper provided by Exeter University, Department of Economics in its series Discussion Papers with number 0610.

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Date of creation: 2006
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Handle: RePEc:exe:wpaper:0610

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Keywords: Monetary Policy; Fiscal Policy; Macroeconomic Stabilisation;

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  1. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  2. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  3. Roberto Billi & Klaus Adam, 2005. "Monetary and Fiscal Interactions without Commitment and the Value of Monetary Conservatism," Computing in Economics and Finance 2005 62, Society for Computational Economics.
  4. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  5. 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.
  6. Joshua Aizenman & Jacob A. Frenkel, 1984. "Optimal Wage Indexation, Foreign-Exchange Intervention and Monetary Policy," NBER Working Papers 1329, National Bureau of Economic Research, Inc.
  7. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  8. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  9. 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.
  10. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
  11. Wicksell, Knut, 1907. "The Influence of the Rate of Interest on Prices," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 17, pages 213-220.
  12. Hughes Hallett, Andrew, 2005. "In Praise of Fiscal Restraint and Debt Rules. What the Euro Zone Might Do Now," CEPR Discussion Papers 5043, C.E.P.R. Discussion Papers.
  13. Carlin, Wendy & Soskice, David, 2004. "The 3-Equation New Keynesian Model: A Graphical Exposition," CEPR Discussion Papers 4588, C.E.P.R. Discussion Papers.
  14. 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.
  15. Blake, Andrew P & Weale, Martin, 1998. "Costs of Separating Budgetary Policy from Control of Inflation: A Neglected Aspect of Central Bank Independence," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 449-67, July.
  16. John B. Taylor, 1995. "The monetary transmission mechanism: an empirical framework," Working Papers in Applied Economic Theory 95-07, Federal Reserve Bank of San Francisco.
  17. SGB Henry & Mathan Satchi & David Vines, 2006. "The Effect of Discounting on Policy Choices in Inflation Targeting Regimes," Economic Journal, Royal Economic Society, vol. 116(508), pages 266-282, 01.
  18. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, vol. 110(462), pages C93-108, March.
  19. Bean, Charles, 1998. "The New UK Monetary Arrangements: A View from the Literature," Economic Journal, Royal Economic Society, vol. 108(451), pages 1795-1809, November.
  20. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
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