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Monetary conservatism and fiscal policy

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Author Info
Klaus Adam
Roberto M. Billi

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Abstract

Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment robustly generates too much inflation. A conservative monetary authority thus remains desirable. When fiscal policy is determined before monetary policy each period, the monetary authority should focus exclusively on stabilizing inflation, as this eliminates the steady state biases associated with lack of monetary and fiscal commitment. It also leads to stabilization policy that is close to if not fully optimal.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 07-01.

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Date of creation: 2007
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Handle: RePEc:fip:fedkrw:rwp07-01

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Keywords: Money Monetary policy Fiscal policy

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  4. 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. [Downloadable!] (restricted)
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  6. 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. [Downloadable!] (restricted)
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  8. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January. [Downloadable!] (restricted)
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  13. Javier Díaz-Giménez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2003. "Nominal Debt as a Burden on Monetary Policy," Economics Working Papers 841, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2006. [Downloadable!]
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  19. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
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  21. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Canale, Rosaria Rita & Foresti, Pasquale & Marani, Ugo & Napolitano, Oreste, 2007. "On Keynesian effects of (apparent) non-Keynesian fiscal policies," MPRA Paper 3355, University Library of Munich, Germany, revised Jun 2007. [Downloadable!]
  2. Rosaria Rita Canale & Pasquale Foresti & Ugo Marani & Oreste Napolitano, 2007. "On Keynesian effects of (apparent) non-Keynesian fiscal policies," Discussion Papers 8_2007, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy. [Downloadable!]
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