Monetary Policy Facing Fiscal Indiscipline under Generalized Timing of Actions

Abstract

The paper analyzes interactions between monetary and fiscal policies, both in a single-country and in a monetary-union setting. As the policy interactions are strategic, we use game-theoretic methods. Specifically, we develop a framework that allows for an arbitrary, possibly stochastic timing of moves. Our analysis identifies a number of institutional and policy variables that influence the interplay and outcomes of monetary and fiscal policies, such as the average levels of inflation and debt, and that determine the likelihood of an unpleasant monetarist arithmetic. We then calibrate the model with European Monetary Union data.