Abstract
The problem of coordination between policymakers seems to have created fundamental problems related to economic and social costs, targeted inflation, potential growth, and a high budget deficit. To resolve these problems in this framework, it is important to see the results of the interaction between policymakers and to propose an optimal policy strategy. In this study, the interactions between monetary and fiscal policymakers are examined game theoretically within the framework of the New Keynesian model. The strategic interaction between these policymakers is assessed using the DSGE (Dynamic Stochastic General Equilibrium) model for a small open economy. From this point of view, the interaction between policymakers is assessed within the framework of hypothetical scenarios. The optimal monetary and fiscal policies for a small open economy are derived from the leader-follower mechanism solution known as the Stackelberg solution. Optimal Stackelberg policy rules derived for a small open economy contribute to the literature of economics. The performance of the game theoretically derived optimal policy rules is evaluated through dynamic simulation within the framework of counterfactual experiments. The parameters developed for the model are calibrated for the Turkish economy. Dynamic simulation of the models, the impulse response functions, and the social loss analysis shows that the optimal policy mix for the Turkish economy is when the monetary policymaker is the leader, and the fiscal policymaker is the follower.
Highlights
In traditional macroeconomics literature macroeconomic policies are formed by the behavior of policymakers
The model dynamic IS equation consists of the New Keynesian Phillips curve equation, government debt payment constraint equation, and interest and spending policy rules derived for leader-follower scenarios
For the operation steps of each scenario, the DYNARE toolbox that runs on the MATLAB program which is developed for the prediction of Dynamic Stochastic General Equilibrium Models was used
Summary
In traditional macroeconomics literature macroeconomic policies are formed by the behavior of policymakers. In the game-theoretical approach to monetary and fiscal policy, policy authorities determine their strategies as leaders or followers and form policies If both policymakers act as followers, the solution will be achieved by Nash equilibrium in the form of a two-stage game where players make their decisions simultaneously without knowing the move of the opponent. The study makes a new contribution to the literature with the game-theoretical analysis of the leader-follower setting between the monetary and fiscal policies we have developed for the small-scale open economy. The interaction between policymakers in small open economies is assessed as the Stackelberg leader-follower game and alternative monetary and fiscal policy rules are derived for the situation in this scenario. Concluding remarks and policy suggestions are presented in the fifth section
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