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Anchors Away: How Fiscal Policy Can Undermine “Good” Monetary Policy

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  • Eric M. Leeper

    ()
    (Indiana University)

Abstract

Slow moving demographics are aging populations around the world and pushing many countries into an extended period of heightened fiscal stress. In some countries, taxes alone cannot or likely will not fully fund projected pension and health care ex- penditures. If economic agents place sufficient probability on the economy hitting its “fiscal limit” at some point in the future—after which further tax revenues are not forthcoming—it may no longer be possible for “good” monetary policy behavior to control inflation or anchor inflation expectations. In the period leading up to the fiscal limit, the more aggressively that monetary policy leans against inflationary winds, the more expected inflation becomes unhinged from the inflation target. Problems con- frontingmonetary policy are exacerbated when policy institutions leave fiscal objectives and targets unspecified and, therefore, fiscal expectations unanchored. 

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Bibliographic Info

Paper provided by Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington in its series Caepr Working Papers with number 2009-021.

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Length: 34 pages
Date of creation: Nov 2009
Date of revision:
Handle: RePEc:inu:caeprp:2009-021

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Cited by:
  1. Eric M. Leeper, 2010. "Monetary science, fiscal alchemy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 361-434.
  2. Luis Felipe Céspedes & Roberto Chang & Diego Saravia, 2011. "Monetary Policy under Financial Turbulence: An Overview," Central Banking, Analysis, and Economic Policies Book Series, in: Luis Felipe Céspedes & Roberto Chang & Diego Saravia (ed.), Monetary Policy under Financial Turbulence, edition 1, volume 16, chapter 1, pages 001-021 Central Bank of Chile.

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