IDEAS home Printed from https://ideas.repec.org/p/fip/fedkrw/rwp10-10.html
   My bibliography  Save this paper

Distortionary fiscal policy and monetary policy goals

Author

Listed:
  • Klaus Adam
  • Roberto M. Billi

Abstract

We study interactions between monetary policy, which sets nominal interest rates, and fiscal policy, which levies distortionary income taxes to finance public goods, in a standard, sticky-price economy with monopolistic competition. Policymakers? inability to commit in advance to future policies gives rise to excessive inflation and excessive public spending, resulting in welfare losses equivalent to several percent of consumption each period. We show how appointing a conservative monetary authority, which dislikes inflation more than society does, can considerably reduce these welfare losses and that optimally the monetary authority is predominantly concerned about inflation. Full conservatism, i.e., exclusive concern about inflation, entirely eliminates the welfare losses from discretionary monetary and fiscal policymaking, provided monetary policy is determined after fiscal policy each period. Full conservatism, however, is severely suboptimal when monetary policy is determined simultaneously with fiscal policy or before fiscal policy each period.

Suggested Citation

  • Klaus Adam & Roberto M. Billi, 2010. "Distortionary fiscal policy and monetary policy goals," Research Working Paper RWP 10-10, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp10-10
    as

    Download full text from publisher

    File URL: http://www.kansascityfed.org/PUBLICAT/RESWKPAP/PDF/RWP10-10.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, pages 1169-1189.
    2. Chakravorti Sujit & Roson Roberto, 2006. "Platform Competition in Two-Sided Markets: The Case of Payment Networks," Review of Network Economics, De Gruyter, pages 1-25.
    3. 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, pages 589-610.
    4. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco.
    5. Javier Diaz-Gimenez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2008. "Nominal Debt as a Burden on Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 493-514, July.
    6. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, pages 183-209.
    7. Niemann, S, 2009. "Dynamic Monetary-Fiscal Interactions and the Role of Monetary Conservatism," Economics Discussion Papers 2899, University of Essex, Department of Economics.
    8. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, pages 198-230.
    9. Adam, Klaus & Billi, Roberto M., 2006. "Monetary conservatism and fiscal policy," Working Paper Series 663, European Central Bank.
    10. Adam, Klaus & Billi, Roberto M., 2008. "Monetary conservatism and fiscal policy," Journal of Monetary Economics, Elsevier, pages 1376-1388.
    11. Adam, Klaus, 2011. "Government debt and optimal monetary and fiscal policy," European Economic Review, Elsevier, pages 57-74.
    12. Adam, Klaus, 2011. "Government debt and optimal monetary and fiscal policy," European Economic Review, Elsevier, pages 57-74.
    13. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, pages 234-247.
    14. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, pages 1187-1211.
    15. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, pages 150-167.
    16. Davis, Donald R, 1998. "The Home Market, Trade, and Industrial Structure," American Economic Review, American Economic Association, pages 1264-1276.
    17. Maskin, Eric & Tirole, Jean, 2001. "Markov Perfect Equilibrium: I. Observable Actions," Journal of Economic Theory, Elsevier, pages 191-219.
    18. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, pages 473-491.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Adam, Klaus, 2011. "Government debt and optimal monetary and fiscal policy," European Economic Review, Elsevier, pages 57-74.
    2. Adam, Klaus & Billi, Roberto M., 2006. "Monetary conservatism and fiscal policy," Working Paper Series 663, European Central Bank.
    3. Cycon, Lisa & Koetter, Michael, 2015. "Monetary policy under the microscope: Intra-bank transmission of asset purchase programs of the ECB," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112831, Verein für Socialpolitik / German Economic Association.
    4. Paul Pichler & Gerhard Sorger & Stefan Niemann, 2011. "Public debt, discretionary policy, and inflation persistence," 2011 Meeting Papers 887, Society for Economic Dynamics.
    5. Niemann, S, 2009. "Dynamic Monetary-Fiscal Interactions and the Role of Monetary Conservatism," Economics Discussion Papers 2899, University of Essex, Department of Economics.
    6. Kick, Thomas & Koetter, Michael & Storz, Manuela, 2016. "Cross-border transmission of emergency liquidity," Discussion Papers 34/2016, Deutsche Bundesbank.
    7. Dimakou, Ourania, 2015. "Bureaucratic corruption and the dynamic interaction between monetary and fiscal policy," European Journal of Political Economy, Elsevier, pages 57-78.
    8. Kick, Thomas & Koetter, Michael & Storz, Manuela, 2017. "Cross-border transmission of emergency liquidity," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168112, Verein für Socialpolitik / German Economic Association.
    9. Stefano Gnocchi, 2013. "Monetary Commitment and Fiscal Discretion: The Optimal Policy Mix," American Economic Journal: Macroeconomics, American Economic Association, pages 187-216.
    10. Adam, Klaus, 2011. "Government debt and optimal monetary and fiscal policy," European Economic Review, Elsevier, pages 57-74.
    11. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, pages 234-247.
    12. Dimakou, Ourania, 2013. "Monetary and fiscal institutional designs," Journal of Comparative Economics, Elsevier, pages 1141-1166.
    13. Flores Unzaga, Ismael Martin & Zhu, Junyi, 2014. "Bracket Creep Revisited: Progressivity and a Solution by Adjusting the Rich Tax in Germany," MPRA Paper 57664, University Library of Munich, Germany.
    14. Adam, Klaus & Billi, Roberto M., 2008. "Monetary conservatism and fiscal policy," Journal of Monetary Economics, Elsevier, pages 1376-1388.
    15. Niemann, Stefan & Pichler, Paul & Sorger, Gerhard, 2013. "Public debt, discretionary policy, and inflation persistence," Journal of Economic Dynamics and Control, Elsevier, pages 1097-1109.
    16. Ali Hussein Samadi & Afshin Montakhab & Hussein Marzban & Sakine Owjimehr, 2017. "Quantum Barro--Gordon Game in Monetary Economics," Papers 1708.05689, arXiv.org.
    17. Klaus Adam, 2010. "Optimal Monetary and Fiscal Stabilisation Policies," OECD Economics Department Working Papers 765, OECD Publishing.
    18. repec:eee:phsmap:v:489:y:2018:i:c:p:94-101 is not listed on IDEAS
    19. Niemann, Stefan & Pichler, Paul, 2011. "Optimal fiscal and monetary policies in the face of rare disasters," European Economic Review, Elsevier, pages 75-92.
    20. Flores Unzaga, Ismael Martin & Zhu, Junyi, 2014. "Bracket Creep Revisited: Progressivity and a Solution by Adjusting the Rich Tax in Germany," EconStor Preprints 100006, ZBW - German National Library of Economics.
    21. Miller, David S., 2016. "Commitment versus discretion in a political economy model of fiscal and monetary policy interaction," Journal of Monetary Economics, Elsevier, pages 17-29.

    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedkrw:rwp10-10. 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: (Lu Dayrit). General contact details of provider: http://edirc.repec.org/data/frbkcus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.