Monetary conservatism and fiscal policy

Klaus Adam () and Roberto M. Billi ()

No 663, Working Paper Series from European Central Bank

Abstract: Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic stochastic sticky price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment robustly generates too much inflation. A conservative monetary authority thus remains desirable. Exclusive focus on inflation by the central bank recoups large part - in some cases all - of the steady state welfare losses associated with lack of monetary and fiscal commitment. An inflation conservative central bank tends to improve also the conduct of stabilization policy. JEL Classification: E52, E62, E63.

Keywords: Banking; sequential non-cooperative policy games; discretionary policy; time consistent policy; conservative monetary policy. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-pbe
Date: 2006-07
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Related works:
Working Paper: Monetary Conservatism and Fiscal Policy (2006)
Working Paper: Monetary conservatism and fiscal policy (2007)
Journal Article: Monetary conservatism and fiscal policy (2008)
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