The Welfare Implications of Fiscal Dominance
This paper studies the interdependence between fiscal and monetary policy in a DSGE model with sticky prices and non-zero trend inflation. We characterize the fiscal and monetary policies by a rule whereby a given fraction k of the government debt must be backed by the discounted value of current and future primary surpluses. The remaining fraction of debt is backed by seigniorage revenues. When k = 1, there is no fiscal dominance, since the fiscal authority backs all debt and accommodates (independent) monetary policy, by adjusting current or future primary surpluses to satisfy the government’s intertemporal budget constraint. If k = 0, all debt is backed by the monetary authority and there is complete fiscal dominance. A continuum of possibilities lies between these two polar cases. We numerically show that: 1) the degree of fiscal dominance, as measured by (1 - k), is positively related to trend inflation, and 2) when prices are sticky, k has significant effects on the business cycle dynamics. The model is estimated using Bayesian techniques. Estimates of k imply a high degree of fiscal dominance in both Mexico and South Korea, but almost no fiscal dominance in Canada and the U.S. The country-specific estimates of the structural parameters are used in a second-order approximation of the equilibrium around the deterministic steady-state to evaluate the welfare costs of fiscal dominance. Results suggest significant welfare losses for countries with high degrees of fiscal dominance.
|Date of creation:||2008|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/
References listed on IDEAS
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.:
- Michael Woodford, 1995.
"Price Level Determinacy Without Control of a Monetary Aggregate,"
NBER Working Papers
5204, National Bureau of Economic Research, Inc.
- Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
- Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc.
- Uribe, Martin, 2006.
"A fiscal theory of sovereign risk,"
Journal of Monetary Economics,
Elsevier, vol. 53(8), pages 1857-1875, November.
- Frank Smets & Raf Wouters, 2003.
"An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area,"
Journal of the European Economic Association,
MIT Press, vol. 1(5), pages 1123-1175, 09.
- Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
- Evan Tanner & Alberto M. Ramos, 2002.
"Fiscal Sustainability and Monetary Versus Fiscal Dominance; Evidence From Brazil, 1991-2000,"
IMF Working Papers
02/5, International Monetary Fund.
- Evan Tanner & Alberto Ramos, 2003. "Fiscal sustainability and monetary versus fiscal dominance: evidence from Brazil, 1991-2000," Applied Economics, Taylor & Francis Journals, vol. 35(7), pages 859-873.
- Schmitt-Grohé, Stephanie & Uribe, Martín, 2004.
"Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the US Business Cycle,"
CEPR Discussion Papers
4654, C.E.P.R. Discussion Papers.
- Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the U.S. Business Cycle," NBER Working Papers 10724, National Bureau of Economic Research, Inc.
- Jan-Egbert Sturm & Jakob de Haan, 2001. "Inflation in Developing Countries: Does Central Bank Independence Matter?," CESifo Working Paper Series 511, CESifo Group Munich.
- Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
When requesting a correction, please mention this item's handle: RePEc:bca:bocawp:08-28. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.