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Redistribution and the monetary–fiscal policy mix

Author

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  • Saroj Bhattarai
  • Jae Won Lee
  • Choongryul Yang

Abstract

We show that the effectiveness of redistribution policy in stimulating the economy and improving welfare is directly tied to how much inflation it generates, which in turn hinges on monetary-fiscal adjustments that ultimately finance the transfers. We compare two distinct types of monetary-fiscal adjustments: In the monetary regime, the government eventually raises taxes to finance transfers while in the fiscal regime, inflation rises, effectively imposing inflation taxes on public debt holders. We show analytically in a simple model how the fiscal regime generates larger and more persistent inflation than the monetary regime. In a quantitative application, we use a two-sector, two-agent New Keynesian model, situate the model economy in a Covid-19 recession, and quantify the effects of the transfer components of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. We find that the transfer multipliers are significantly larger under the fiscal regime—which results in a milder contraction than under the monetary regime, primarily because inflationary pressures of this regime counteract the deflationary forces during the recession. Moreover, redistribution produces a Pareto improvement under the fiscal regime.

Suggested Citation

  • Saroj Bhattarai & Jae Won Lee & Choongryul Yang, 2020. "Redistribution and the monetary–fiscal policy mix," CAMA Working Papers 2020-107, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:een:camaaa:2020-107
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    File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2020-12/107_2020_bhattarai_lee_yang.pdf
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    References listed on IDEAS

    as
    1. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246, National Bureau of Economic Research, Inc.
    2. repec:fth:harver:1435 is not listed on IDEAS
    3. Gergo Motyovszki, 2021. "Monetary-Fiscal Interactions and Redistribution in Small Open Economies," Economics Working Papers EUI ECO 2020/03, European University Institute.
    4. Saroj Bhattarai & Jae Won Lee & Woong Yong Park & Choongryul Yang, 2019. "Macroeconomic effects of capital tax rate changes," CESifo Working Paper Series 7630, CESifo.
    5. Faria-e-Castro, Miguel, 2021. "Fiscal policy during a pandemic," Journal of Economic Dynamics and Control, Elsevier, vol. 125(C).
    6. Margaret M. Jacobson & Eric M. Leeper & Bruce Preston, 2019. "Recovery of 1933," NBER Working Papers 25629, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Household heterogeneity; Redistribution; Monetary-fiscal policy mix; Transfer multiplier; Welfare evaluation; Covid-19; CARES Act;
    All these keywords.

    JEL classification:

    • E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • 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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