Learning the Fiscal Monetary Interaction under Trend Inflation

Anna Florio and Alessandro Gobbi ()
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Alessandro Gobbi: Department of Economics and Finance, Universita Cattolica del Sacro Cuore

No 68, DEM Working Papers Series from University of Pavia, Department of Economics and Management

Abstract: What are the effects of a higher inflation target on the determinacy properties under alternative monetary/fiscal policy mixes in New Keynesian models? Would it be more difficult for the central bank to stabilize inflation expectations if the inflation target is raised? What role for central bank transparency? We find that trend inflation does not affect determinacy as long as monetary policy is passive. Conversely, an active central bank should fight inflation more strongly with higher trend inflation, in order to guarantee the determinacy of the AM/PF equilibrium. Furthermore, this equilibrium, if determinate, is always E-stable under transparency. In the AF/PM case the equilibrium is always determinate and E-stable under both transparency and opacity. We find the degree of price stickiness to be a crucial structural parameter. In particular, in a low price rigidity country, say the United States, adhering to the Taylor principle is a sufficient condition for equilibrium determinacy under the AM/PF regime, irrespective of the level of trend inflation. Still, the central bank must be transparent to stabilize expectations. On the contrary, in a high price rigidity economy, say Europe, to have determinacy under AM/PF mix, the inflation target cannot be larger than 2% but the central bank needs not to be transparent to stabilize expectations. Furthermore, high rigidity makes non-Ricardian policies less E-stable.

Keywords: Trend Inflation; Learning; Fiscal Policy; Monetary Policy; Transparency (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2014-02
New Economics Papers: this item is included in nep-mac and nep-mon
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