Two Naked Emperors? Concerns about the Stability and Growth Pact and Second Thoughts About Central Bank Independence

Willem Hendrik Buiter

No 4001, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This 2003 Institute for Fiscal Studies Lecture addresses two sets of issues relevant to current and prospective future E(M)U members: the consequences of the Stability and Growth Pact for fiscal-financial sustainability and macroeconomic stability, and some risks associated with operational independence of the central bank. The relevance of the second issue is not restricted to E(M)U members. Poor communication, cooperation and coordination between the fiscal and monetary authorities can be costly in two contingencies. The first of these occurs when the central bank’s role as the lender of last resort needs to be backed up by the willingness of the Treasury to recapitalize the central bank, should the need arise. The second contingency occurs when unwanted deflation needs to be prevented or combated, but the central bank’s conventional monetary arsenal is exhausted. Friedman’s helicopter drop of money, a temporary tax cut or transfer payment increase financed through the issuance of base money will always stimulate demand provided it is not expected to be reversed, in present value terms, in the future. In most real-world institutional/legal settings the implementation of a helicopter drop of base money requires coordinated actions by the central bank and Treasury. Central bank independence is unlikely to survive if either or both of these contingencies occur, if there is an ineffective response by the fiscal and monetary authorities and if this is blamed on lack of communication, cooperation or coordination.

Keywords: central bank independence; deflation; fiscal rules; helicopter money drop; lender of last resort; stability and growth pact; zero bound (search for similar items in EconPapers)
JEL-codes: E31 E32 E42 E61 E62 E63 F33 F41 F42 H62 H87 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-hpe, nep-mon and nep-pbe
Date: 2003-08
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