Monetary Policy Interactions Research Articles

Monetary and Fiscal Policy Interaction in the Euro Area with Different Assumptions on the Phillips Curve

In this Paper, we carry over a static version of a New Keynesian Macromodel a la Clarida Gali Gertler (1999) to a monetary union. We will show in particular that a harmonious functioning of a monetary union critically depends on the correlation of shocks that hit the currency area. Additionally, a high degree of integration in product markets is advantageous for the ECB as it prevents that national real interest rates can drive a wedge between macroeconomic outcomes across member states. In particular, small countries are vulnerable and, therefore, in need of fiscal policy as an independent stabilization agent with room to breath.

Comments on “Fiscal and monetary policy interactions: Empirical evidence on optimal policy using a structural new-Keynesian model”

1. The objectiveThe objective of this paper is the empirical assessment of strategic complementar-ity or substitutability of fiscal and monetary policy.I believe that the most relevant issue on the interaction between monetary and fis-cal policies is the amount of coordination among the authorities necessary for eachauthority to reach its own goals. In a recent paper Sims (2003) has stressed that aprerequisite for central bank to control inflation is appropriate coordination withor backup by fiscal policy and that the nature of the required coordination dependson whether and how central bank independence from fiscal authorities has beenimplemented. The importance of the coordination between monetary and fiscalauthorities to achieve inflation stabilization has been originally strongly emphasizedin by Sargent and Wallace (1981) who illustrated how an undisciplined fiscal policymay exert pressures on the monetary authority to sooner or later monetize the def-icit. A different stream of the literature, usually categorized as the fiscal theory of theprice level (FTPL), puts at the center stage the role of the (monetary and fiscal) QTRpolicy mix in determining the joint dynamics of inflation and output. According tothis view, the strong anti-inflationary policy pursued in the US with the onset ofthe Volcker–Greenspan regime would not have sufficed to successfully moderateinflation without the fiscal adjustment that characterized the US economic policythroughout the nineties. While the argument pursued in several contributions of

Fiscal and monetary policy interactions: Empirical evidence and optimal policy using a structural New-Keynesian model

This paper examines the interaction of monetary and fiscal policies using an estimated New-Keynesian dynamic general equilibrium model for the US. In contrast to earlier work using VAR models, we show that the strategic complementarity or substitutability of fiscal and monetary policy depends crucially on the types of shocks hitting the economy, and on the assumptions made about the underlying structural model. We also demonstrate that countercyclical fiscal policy can be welfare-reducing if fiscal and monetary policy rules are inertial and not co-ordinated.

Monetary Regimes and Core Inflation

This paper examines the interaction of core inflation and monetary policy. Interest in core has grown because of inflation targeting. Core inflation is defined in numerous ways giving rise to many potential measures; I define core inflation as the best forecaster of inflation. A cross-country study finds that core inflation differs across monetary regimes. A theoretical model shows that in an accommodative regime lagged inflation is core inflation and in a non-accommodative regime, such as strict inflation targeting, the trimmed mean is core. Using unconditional regressions I find that the theoretical model holds empirically. Through conditional regressions, inflation expectations are found to be consistent with the accommodativeness of the central bank.

Fiscal and monetary policy coordination in EMU

The purpose of this paper is to analyze and discuss the coordination of fiscal and monetary policies in EMU. In section 2, we develop a framework for studying monetary and fiscal policy in a monetary union to explore the implications of the common currency for policy coordination. We show that there is little need for coordinating monetary and fiscal policies in the long run. In section 3, we study the interaction of monetary and fiscal policies in the short run. A monetary policy firmly committed to price stability at the EMU level implies that the central bank controls aggregate output at the euro-area level, while national fiscal policies determine the distribution of aggregate demand across the participating countries. Thus, national governments are engaged in a purely distributional game with inefficient outcomes unless policies are coordinated. If monetary policy also pursues a goal of output stabilization, policy coordination should include the central bank together with the fiscal authorities. We also show that the proposal to restrict fiscal policies to the operation automatic stabilizers at the national level, which is now often made in EMU, does not solve the issue of policy coordination. Instead, it worsens the situation of the central bank unless automatic stabilizers are identical in all member economies. In section 4, we review the existing mechanisms for policy coordination and show that they are deficient, since they focus on the long run rather than the short run and largely ignore the interdependence of national economic policies and the ECB’s monetary policy. Section 5 concludes. (This abstract was borrowed from another version of this item.)

Bank borrowing constraints and the demand for trade credit: evidence from panel data

AbstractMonetary policy contractions exacerbate credit constraints stemming from asymmetric information, incentive problems and limited collateral. During such periods financial intermediaries reduce the supply of credit to smaller businesses. Although trade credit is a less desirable alternative of corporate financing, it may play a special role in alleviating credit rationing. This paper is an empirical investigation of the interaction of monetary policy, credit market conditions and corporate financing over the business cycle. It provides a simple test of the existence of a credit channel of monetary policy transmissions. Using individual firm data we find that during periods of tight money the proportion of bank‐borrowing constrained firms increases. Borrowing constrained films are found to substitute away from bank credit to trade credit. Such evidence supports the existence of a credit channel of monetary policy transmission: firms do not voluntarily cut bank loans (e.g. because of demand slowdown) since they increase their demand for a less desirable alternative (trade credit). Copyright © 2003 John Wiley & Sons, Ltd.

Interactions between monetary and fiscal policy under flexible exchange rates

We examine fiscal and monetary policy interactions by developing a two-country open-economy model under flexible exchange rates, where overlapping generations of consumers supply labour to imperfectly competitive firms that change their prices infrequently. We show in this context that the implications of lax fiscal policy in country A are significant for country B. Determinacy can be ensured by adopting a ‘passive’ monetary policy in either country A or country B. In both cases, however, lack of fiscal feedback in country A will imply that fiscal shocks have significant macroeconomic consequences for both countries. We examine how the size of these spillovers is influenced by the degree of debt indexation. We also show that the fiscal response required to support an active monetary policy is greater when consumers have finite lives and that the characterisation of ‘active’ and ‘passive’ regimes does not depend on whether or not debt is indexed.

The Assessment: EMU, Four Years On

This paper reviews the functioning of the Economic and Monetary Union over the first 4 years of its existence. Monetary policy is viewed as having been of the 'inflation-targeting' type, but with a tendency towards delay and conservatism in adjustment, which may also reflect over-optimistic output growth forecasts. The resulting pressure on the Stability and Growth Pact (SGP) illustrates the weakness in the 'consensus view' of the harmonious interaction of monetary, fiscal, and supply-side policies, which requires policy in all three areas to be 'correct'. In discussing reform of the SGP, a looser but still constraining form of fiscal agreement is advocated. The supply-side and balance-of-payments issues involved in inter-country adjustment also interact importantly with the SGP and are identified as key areas of difficulty in a still 'immature' monetary union, with separate labour-market structures. Here the mechanisms for coordination are more or less absent. Copyright 2003, Oxford University Press.

Fiscal and Monetary Policy Interactions: Empirical Evidence and Optimal Policy Using a Structural New Keynesian Model

This paper examines the interaction of monetary and fiscal policies using an estimated New Keynesian dynamic general equilibrium model for the US. In contrast to earlier work using VAR models, we show that the strategic complementarity or substitutability of fiscal and monetary policy depends crucially on the types of shocks hitting the economy, and on the assumptions made about the underlying structural model. We also demonstrate that countercyclical fiscal policy can be welfare-reducing if fiscal and monetary policy rules are inertial and not co-ordinated.

Effects of Fiscal Policy on the Durability of Low Inflation Regimes

This paper deals with the interaction of fiscal and monetary policy when the central bank is pursuing a price stability-oriented monetary policy. In particular, we study the durability of the price stability regime when public debt accumulates as a result of ultimately unsustainable deficits. The growth of indebtedness causes the collapse of the price stability regime after a period of rising deficits. The budget deficit is endogenously determined in the model, as a result of government's decisions on how to finance its expenditure. The alternative methods of finance are taxes, debt, and seigniorage. Under the price stability regime, only the first two methods are available, but in the long run taxes and seigniorage are the only alternatives. The price stability regime collapses when the public debt reaches an edogenously determined threshold, which makes reneging on price stability as attractive as accumulating more tax burden for the future. We are able to solve for the critical level of debt, the timing of the collapse, and the reaction of taxes to the collapse of the price stability regime. The critical level of debt depends, inter alia, on the level of government consumption, the real interest rate, the velocity of money, and the efficiency-effects of taxation. The results are illustrated by several numerical simulations.

The fiscal dimension of a common monetary policy: results with a non-Ricardian global model

The paper studies the interaction of fiscal and monetary policy within an Economic and Monetary Union (EMU). Results suggest that, in a model in which bonds and money are counted as net wealth, an important source of cross-country heterogeneity in response to a common monetary shock is the differences in national economies' budgetary positions. In particular, we note that centralising seigniorage revenues may lead, in the long term, to wealth redistribution across countries. Although institutional arrangements such as the Stability Pact might not be necessary to ensure fiscal sustainability, its strict enforcement is shown to be associated with overall ever-lasting benefits. Transition to the new steady state is, however, likely to be remarkably costly for high-debt EMU countries. Finally, different degrees of efficiency characterising European credit markets do not seem to play a major role in explaining asymmetric responses.

EMU, Monetary Policy Interactions and Exchange Rate Stability

EMU leads to the elimination of monetary policy coordination failures within the euro area. Whether this translates into more transatlantic exchange rate stability depends on the origin of economic shocks. Martin's (1997) conclusion that EMU will lead to more stable exchange rates is shown to hold for both symmetric and asymmetric shocks in Europe, but not for shocks that originate outside Europe. The results remain valid when taking into account that the pre-EMU era was characterised by a Bundesbank-led ERM, rather than a free float. Finally, the results are checked for a future expansion of the euro area.

Monetary and Fiscal Policy Interaction in the EMU: A Dynamic Game Approach

The interaction of monetary and fiscal policies is a crucial issue in a highly integrated economic area as the European Union. We argue that EMU, which introduced a common monetary policy and restrictions on fiscal policy at the national level, increases the need for macroeconomic policy cooperation. To study the effects of policy cooperation we compare the effects of three alternative policy regimes in a stylized dynamic model of a monetary union: (i) noncooperative monetary and fiscal policies, (ii) partial cooperation, and (iii) full cooperation both in symmetric and asymmetric settings where countries differ in structural characteristics, policy preferences and/or bargaining power. The paper introduces an analysis of coalitional behavior in a dynamic setting into the literature.

Monetary and fiscal policy design in the EMU: An overview

The interaction of monetary and fiscal policies is a crucial issue in a highly integrated economic area such as the European Union. This paper analyzes the design of monetary and fiscal policies in the EMU. To do so, the paper starts with an overview of the most important aspects. Next, it analyzes monetary and fiscal policy interaction in a stylized model of a monetary union, in which monetary and fiscal policy design is modeled as a dynamic stabilization game. Macroeconomic policy making and adjustment are studied under alternative forms of cooperation and in both symmetric and asymmetric settings.

Monetary and Fiscal Policy Interactions Over the Cycle: Some Empirical Evidence

Monetary and Fiscal Policy Interactions Over the Cycle: Some Empirical Evidence

Monetary and Fiscal Policy Interactions in a Micro-Founded Model of a Monetary Union

So far, the 'new open economy macroeconomics' literature has primarly focused on monetary policy and monetary policy rules, rather than paying attention also to fiscal policy. This is an omission because, especially with the advent of EMU, the burden on fiscal policy as an instrument for macroeconomic stabilization has potentially increased. In this paper, we focus on the interactions between monetary and fiscal policy in a micro-founded model of a monetary union. By extending a two-country, New Keynesian model with public spending, we find that the forward-looking Phillips curves depend on consumption, terms-of-trade and public spending deviations from their respective stochastic natural settings. We study the optimal coordinated monetary and fiscal policy settings for variuos settings. We also consider simple monetary and fiscal policy rules and investigate to what extent these rules can approximate the optimal solution under commitment. JEL Classification: E52, E61, E62, E63, F33

Debt-contingent inflation contracts and targets

This paper analyzes fiscal and monetary policy interaction in a simple policy game with debt and output shocks. Seigniorage provides revenue for the government but results in an inflation-bias. We analyze three mechanisms designed to eliminate some or all of the biases in monetary policy: an inflation performance contract, inflation target (both contingent on the stock of debt), and a zero-inflation rule. The performance contract and inflation target result in higher interest rate, remove all biases in monetary policy and achieve the pre-commitment policy, hence they are equivalent. The first two solutions also yield a higher expected welfare than a zero-inflation policy.

Coalitional Behavior in an Open-Loop Lq-Differential Game for the EMU

The interaction of monetary and fiscal policies is a crucial issue in a highly integrated economic area like the EU. In this paper we study policy cooperation. In particular, we focus on how coalitions among policy-makers are formed and what their effects are on the stabilization of output and price.

Fiscal deficits, monetary reform and inflation stabilization in romania

Fiscal problems are widely recognized as a key factor behind persistent inflation in Eastern Europe post-1989. Deficits need to be cut back, but how much for a given inflation target? We develop a simple framework on debt, deficit and inflation to study the fiscal and monetary policy interactions for the Romanian economy. This framework is employed to assess consistency between inflation, monetary reform and fiscal policy in Romania. First, the direct impact of inflation on fiscal inconsistency measure is assessed. A discussion on the importance of consolidating public sector deficit and its implications for a correct assessment of consistency between monetary and fiscal policy follows. Next, we discuss the implications of exchange rate policy on fiscal sustainability. Finally we alter debt dynamic process to simulate the impact of delaying fiscal adjustment on fiscal sustainability.

Macroeconomic Policy Interaction under EMU: A Dynamic Game Approach

In this article, we study macroeconomic stabilization in the Economic and Monetary Union (EMU) using a dynamic game approach. With the aid of a stylized macroeconomic model, this article analyzes the transmission and interaction of national fiscal policies and monetary policy of the European Central Bank (ECB) in the EMU. A special focus is on the effects of labor market institutions in the participating countries and of the introduction of fiscal stringency criteria like those imposed in the Stability and Growth Pact.