Decentralised Policies and Efficient Trade-Offs: An Essay on the Costs of Uncoordinated Fiscal and Monetary Policies

Andrew Hughes Hallett and Maria Luisa Petit

No 251, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: In many countries two decision-making institutions, the government and the central bank, manage fiscal and monetary policy separately. Such decentralization can lead to a change in the optimal inflation-output trade-off. In fact lack of cooperation can result in a change in the position of the trade-off curve, or a reversal in the slope of this trade-off, or even the total absence of any exploitable trade-off. In this paper the techniques of differential game theory are used to calculate the efficient inflation-output trade-off within a continuous-time econometric model of the Italian economy, in order to examine the differences in the 'policy possibility frontiers' which arise as the result of cooperative and of noncooperative decision-making. The results show that the outcomes obtained in the case of noncooperation are inferior to those under cooperation, and also impose a policy conflict which would not otherwise be present. Moreover the range of policy choices open to the policy-makers is reduced under noncooperation. The results indicate that efficiency gains are not the only reason for coordinating fiscal and monetary policies.

Keywords: Agency Coordination; Continuous Time Models; Differential Games; Fiscal Policy; Italy; Monetary Policy (search for similar items in EconPapers)
Date: 1988-07
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