Brothers in Arms: Monetary-Fiscal Interactions Without Ricardian Equivalence

Å ukasz Rachel and Morten Ravn

No 20445, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study equilibrium outcomes in a model with monetary-fiscal interaction when Ricardian Equivalence fails and argue that the latter feature has fundamental consequences. First, there is no longer any clear distinction between active and passive fiscal policies - there is always some monetary-fiscal interaction. Second, the equilibrium displays local determinacy for a much larger range of monetary and fiscal rules than in representative agent models. Third, the Taylor principle no longer applies in the sense that it is neither necessary nor sufficient for local determinacy. Fourth, when Ricardian equivalence fails and the equilibrium is locally determinate, fiscal deficits are generally inflationary, and their timing matters. These results hold both in a simple three-equation New Keynesian model and in a medium-scale setting when agents have finite planning horizons.

Keywords: Monetary-fiscal; interaction (search for similar items in EconPapers)
JEL-codes: E32 E52 E62 E63 (search for similar items in EconPapers)
Date: 2025-07
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