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Coordinating monetary and fiscal policies: a role for rules?

  • Goyal, Ashima

The chapter argues for rules to coordinate monetary and fiscal policies. But the rules are rule like only in imposing forward-looking behaviour, while they allow the discretion to respond to shocks. They would serve to anchor expectations, and align private sector actions with desired outcomes. Many countries have used rules, but credible rules have to be suited to a country’s circumstances, which include both structure and political economy. These aspects help to explain past policy choices and outcomes in India, such as the relatively low inflation, even though monetary policy was not autonomous. Prices were kept down partly through administrative measures and subsidy schemes. This led to distortions that lowered efficiency and growth. The constraints need to be stricter for fiscal compared to monetary policy, in order to restrain the competitive populism of elected governments. If fiscal-deficit zone targeting restrains government consumption expenditure while protecting essential expenditure on physical and human capital, it would become possible to lower Indian real interest rates closer to world levels. Recent advances in the theory of monetary policy show how the CB can influence the real interest rate in the short- to medium-run, taking account of expected inflation in setting nominal interest rates while smoothing the latter. Exchange rate policy could also be further fine-tuned to fulfil the objectives of stabilising prices, stimulating exports, and preventing a currency crisis. Since accountability, in a democratic polity, forces the CB to keep inflation low, a weak constraint on the CB, such as medium-term inflation zone targeting, is credible. This would allow productivity improvement to decrease inflation, under expanding potential output.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29200.

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Date of creation: 2002
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Handle: RePEc:pra:mprapa:29200
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