Fiscal stabilization with partial exchange rate pass-through
AbstractThis paper examines the role of fiscal stabilization policy in a two-country framework that allows for a general degree of exchange rate pass-through. I derive analytical solutions for optimal monetary and fiscal policy which are shown to depend on the degree of pass-through. In the case of partial pass-through, an optimizing policy maker uses countercyclical fiscal stabilization in addition to monetary stabilization. However, in the extreme cases of complete or zero pass-through, the fiscal stabilization instrument is not employed. There is also no additional gain from the fiscal instrument in the case of coordination between the two countries. These results are due to the specific way the optimal fiscal policy rule affects marginal costs: Rather than being a substitute for monetary policy, fiscal policy complements it by increasing the correlation of the marginal cost terms within and across countries. This in turn makes monetary policy more effective at stabilizing them.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 31.
Date of creation: 2009
Date of revision:
Other versions of this item:
- Erasmus K. Kersting, 2013. "Fiscal Stabilization With Partial Exchange Rate Pass-Through," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 348-367, 01.
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- NEP-OPM-2009-08-16 (Open Economy Macroeconomic)
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