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Welfare Improving Coordination Of Fiscal And Monetary Policy

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  • Andrew Hughes Hallet
  • Jan Libich
  • Petr Stehlik

Abstract

The paper considers a simple model in which monetary and fiscal policies are formally independent, but still interdependent - through their spillovers onto the macroeconomic targets to which they are not primarilly assigned. It shows that the average equilibrium levels of inflation, deficit, debt, and output depend on the two policies?(i) potency (elasticity of output with respect to the policy instruments); (ii) ambition (the level of their output target); and (iii) conservatism (inflation vs output volatility aversion). However, it is the relative degrees of these characteristics that matter, rather than the absolute degrees for each policy. Therefore, and as expected, coordination of monetary and fiscal policy is found to be superior to non-cooperative Nash behaviour for both policymakers. Interestingly though, it is coordination in terms of the policies?ambition, rather than conservatism, that is essential. That is a new result. Furthermore, ambition-coordination can be welfare improving even if the policymakers?objectives are idiosyncratic, and/or even their coordinated output targets differ from the socially optimal one.

Suggested Citation

  • Andrew Hughes Hallet & Jan Libich & Petr Stehlik, 2008. "Welfare Improving Coordination Of Fiscal And Monetary Policy," CAMA Working Papers 2008-04, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:een:camaaa:2008-04
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    References listed on IDEAS

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    1. Hughes Hallett, A J, 1986. "Autonomy and the Choice of Policy in Asymmetrically Dependent Economies: An Investigation of the Gains from International Policy Co-ordination," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 516-544, November.
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    5. Andrew Hughes Hallett & Jan Libich, 2007. "Fiscal-monetary Interactions: The Effect of Fiscal Restraint and Public Monitoring on Central Bank Credibility," Open Economies Review, Springer, vol. 18(5), pages 559-576, November.
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    8. Bas van Aarle & Jacob Engwerda & Joseph Plasmans, 2002. "Monetary and Fiscal Policy Interaction in the EMU: A Dynamic Game Approach," Annals of Operations Research, Springer, vol. 109(1), pages 229-264, January.
    9. Hughes Hallett, Andrew & Libich, Jan & Stehlík, Petr, 2007. "Monetary and Fiscal Policy Interaction with Various Degrees and Types of Commitment," CEPR Discussion Papers 6586, C.E.P.R. Discussion Papers.
    10. Andrew Hallett & Jan Libich, 2012. "Explicit inflation targets and central bank independence: friends or foes?," Economic Change and Restructuring, Springer, vol. 45(4), pages 271-297, November.
    11. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 100(4), pages 1169-1189.
    12. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
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    14. Currie, David & Holtham, Gerald & Hughes, Gordon, 1989. "The Theory and Practice of International Policy Coordination: Does Coordination Pay?," CEPR Discussion Papers 325, C.E.P.R. Discussion Papers.
    15. Hughes Hallett, Andrew & Libich, Jan & Stehlík, Petr, 2009. "Rogoff revisited: The conservative central banker proposition under active fiscal policies," Economics Letters, Elsevier, vol. 104(3), pages 140-143, September.
    16. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-167, March.
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    Cited by:

    1. Nasir, Muhammad Ali, 2021. "Zero Lower Bound and negative interest rates: Choices for monetary policy in the UK," Journal of Policy Modeling, Elsevier, vol. 43(1), pages 200-229.
    2. Andrew Hughes Hallett & Jan Libich & Petr Stehlík, 2011. "Macroprudential Policies and Financial Stability," The Economic Record, The Economic Society of Australia, vol. 87(277), pages 318-334, June.
    3. Daly, Hounaida & Smida, Mounir, 2013. "La coordination des politiques monétaire et budgétaire: Aperçu théorique [Coordination of monetary and fiscal policies: Theoretical Overview]," MPRA Paper 48020, University Library of Munich, Germany.
    4. Hughes Hallett, Andrew & Libich, Jan & Stehlík, Petr, 2009. "Rogoff revisited: The conservative central banker proposition under active fiscal policies," Economics Letters, Elsevier, vol. 104(3), pages 140-143, September.
    5. Muhammad Ali Nasir & Alaa M. Soliman & Milton Yago & Junjie Wu, 2016. "Macroeconomic Policies Interaction & the Symmetry of Financial Markets’ Responses," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 5(1), pages 53-69.
    6. Muhammad Ali Nasir & Alaa M. Soliman & Muhammad Shahbaz, 2021. "Operational aspect of the policy coordination for financial stability: role of Jeffreys–Lindley’s paradox in operations research," Annals of Operations Research, Springer, vol. 306(1), pages 57-81, November.
    7. Hounaida Daly & Taha Khairy Taha Ibrahim, 2023. "Stability and performance of monetary and fiscal policies in the euro area," International Journal of Applied Economics, Finance and Accounting, Online Academic Press, vol. 16(2), pages 208-221.
    8. Daly, Hounaida & Smida, Mounir, 2013. "Interaction entre politique monétaire et politique budgétaire:Cas de la Grèce [Fiscal and Monetary Policy Interactions : The Greece Case]," MPRA Paper 45931, University Library of Munich, Germany.
    9. Muhammad Ali Nasir & Alaa M. Soliman, 2014. "Aspects of Macroeconomic Policy Combinations and Their Effects on Financial Markets," Economic Issues Journal Articles, Economic Issues, vol. 19(1), pages 95-118, March.
    10. Roger Alejandro Banegas Rivero & Marco Alberto Nunez Ramirez & Sacnicte Valdez Del Rio, 2021. "Interaction of Economic Policy. Lessons on Social Welfare and Risk Premium," Montenegrin Journal of Economics, Economic Laboratory for Transition Research (ELIT), vol. 17(1), pages 7-29.
    11. Daly, Hounaida & Smida, Mounir, 2014. "Fiscal Theory of Price Level," MPRA Paper 60142, University Library of Munich, Germany.

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    More about this item

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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