Simple Monetary Rules under Fiscal Dominance

Michael Kumhof, Ricardo Nunes and Yakadina Irina

MPRA Paper from University Library of Munich, Germany

Abstract: This paper asks whether an aggressive monetary policy response to inflation is feasible in countries that suffer from fiscal dominance, as long as monetary policy also responds to fiscal variables. We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. But following such rules results in extremely volatile inflation. This leads to very frequent violations of the zero lower bound on nominal interest rates that make such rules infeasible. Even within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance.

Keywords: Optimal simple policy rules; fiscal dominance (search for similar items in EconPapers)
JEL-codes: E40 (search for similar items in EconPapers)
Date: 2007-08
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Simple Monetary Rules under Fiscal Dominance (2010)
Journal Article: Simple Monetary Rules under Fiscal Dominance (2010)
Working Paper: Simple monetary rules under fiscal dominance (2008)
Working Paper: Simple Monetary Rules Under Fiscal Dominance (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:4462

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