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Interactions between Monetary Policy and Fiscal Fiscal Rules

Author

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  • Leith, C.
  • Wren-Lewis, S.

Abstract

The Fiscal Stability Pact for EMU suggests that constraints on fiscal policy are thought by policy makers to be necessary to ensure that the independent European central bank can control inflation. In this paper we examine the interrelationship between monetary and fiscal policy when both follow simple rules. We identify two stable policy regimes. In the 'active' regime, defined as a monetary policy that seeks to raise real interest rates in response to excess inflation, a self-stabilising fiscal policy is required to ensure model stability. In the corresponding 'passive' regime, a fiscal policy which does not, by itself, ensure fiscal solvency constrains monetary policy to be relatively 'passive'. The precise nature of these constraints depends upon the importance of money and the degree to which the economy deviates from Ricardian Equivalence. We then present simulations which analyse the impact of differing degrees of policy activism in the face of shocks. Our conclusion is that the central bank does not need to seek, on this account, the degree of debt stabilisation that appears to be implied by the fiscal stability pact.

Suggested Citation

  • Leith, C. & Wren-Lewis, S., 1999. "Interactions between Monetary Policy and Fiscal Fiscal Rules," Discussion Papers 9913, Exeter University, Department of Economics.
  • Handle: RePEc:exe:wpaper:9913
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    Cited by:

    1. Maria Demertzis & Andrew Hughes Hallett & Nicola Viegi, 1999. "Can the ECB be Truly Independent? Should It Be?," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 26(3), pages 217-240, September.

    More about this item

    Keywords

    FISCAL POLICY ; MONETARY POLICY ; INFLATION;

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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