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Monetary/Fiscal Mix and Agents' Beliefs

Francesco Bianchi

No 1254, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: This paper investigates the role of the fiscal/monetary policy mix in explaining the rise and fall of inflation. I make use of a DSGE model in which agents are aware of the possibility of regime changes in the monetary/fiscal policy mix in order to study the potential role of the lack of fiscal discipline in explaining the rise of inflation in the '70s. The results will then be used to investigate the long-run consequences of the current crisis under different assumptions around what agents expect policy makers will do in the future. Most importantly, I will try to argue that important effects could arise simply from the uncertainty characterizing the behavior of policy makers. In other words, what agents believe is going to happen in the future has an impact on the economy today, independent of the realization of those beliefs. This is related to the core argument of the Fiscal Theory of Price Level (FTPL): Off equilibria behavior is what really matters.

Date: 2010
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