Inflation and Financial Stability Trade‐off: Role of Monetary Policy Credibility and Fiscal Cyclicality

Akhmad Syakir Kurnia, Syahid Izzulhaq, Johan Beni Maharda and Agung Kunaedi

Economic Papers, 2021, vol. 40, issue 1, 31-53

Abstract: This paper examines the role of monetary credibility and fiscal cyclicality in generating the trade‐off between inflation rates and financial stability. We systematically develop simple theoretical models to shape the rationalisation framework, which demonstrates the role of fiscal cyclicality behaviour in arousing a trade‐off for the monetary policy to target low inflation rates and a stable financial system at the same time. By utilising the generalised method of moment (GMM), we find that a credible monetary policy generates a trade‐off between inflation and financial stability as long as the fiscal policy is procyclical.

Date: 2021
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