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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. John B. Taylor, 1995. "The Monetary Transmission Mechanism: An Empirical Framework," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 11-26, Fall.
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  3. 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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  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. 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.
  17. 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.
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  19. 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.
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