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Fragmented fiscal policymaking and monetary policy: Policy game in a New Keynesian economy

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  • Niwa, Hidekazu

Abstract

We develop a New Keynesian model in which two interest groups influence fiscal policymaking and the fiscal authority issues long-term government debt. Each interest group selects a level of production subsidy that its firms receive from the fiscal authority. We compute responses of macroeconomic variables to a positive government debt shock by analyzing a dynamic game in which the interest groups act as leaders and the central bank as a follower. Because the interest groups do not fully internalize how subsidy changes affect the fiscal balance, strategic interactions between the two interest groups and the central bank through the government budget constraint delay the reduction in government debt, causing high inflation in the long run. We further show that a shorter duration of government debt intensifies each interest group's incentive to free ride on monetary policy.

Suggested Citation

  • Niwa, Hidekazu, 2026. "Fragmented fiscal policymaking and monetary policy: Policy game in a New Keynesian economy," Economic Modelling, Elsevier, vol. 155(C).
    • Handle: RePEc:eee:ecmode:v:155:y:2026:i:c:s0264999325004250
    DOI: 10.1016/j.econmod.2025.107430
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