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Monetary/Fiscal Policy Mix and Agent's Beliefs

Francesco Bianchi () and Cosmin Ilut

Review of Economic Dynamics, 2017, vol. 26, 113-139

Abstract: We estimate a model for the US economy with monetary/fiscal policy mix changes. Monetary policy accommodated fiscal policy through the '60s-'70s leading to high inflation. Monetary policy changed with Volcker, but inflation dropped only when fiscal policy and agents' beliefs about fiscal backing switched; successful disinflations require fiscal backing. If the monetary authority had always led or if agents had been confident about this switch, the Great Inflation would not have occurred. The policy change explains why, in the '80s, inflation dropped, debt-to-GDP reversed, output fell, and inflation persistence and volatility declined. Absent this change, inflation would have remained high for fifteen years. (Copyright: Elsevier)

Keywords: Fiscal policy; monetary policy; inflation; Bayesian methods; Markov-switching DSGE (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.red.2017.02.011

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