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Monetary and Fiscal Interactions without Commitment and the Value of Monetary Conservatism

  • Roberto Billi
  • Klaus Adam

    ()

    (Research Department CEPR and European Central Bank)

We study monetary and fiscal policy games in a dynamic sticky priceeconomy where monetary policy sets nominal interest rates and fiscal policy provides public goods financed with distortionary labor taxes. We compare the Ramsey outcome to non-cooperative policy regimes where one or both policymakers lack commitment power. Absence of fiscal commitment gives rise to a public spending bias, while lack of monetary commitment generates the well-known inflation bias. An appropriately conservative monetary authority can eliminate the steady state distortions generated by lack of monetary commitment and may even eliminate the distortions generated by lack of fiscal commitment. The costs associated with the central bank being overly conservative seem small, but insufficient conservatism may result in sizable welfare losses

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 62.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:62
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