Fiscal and Monetary Policy Coordination, Macroeconomic Stability, and Sovereign Risk

Dennis Bonam and Jasper Lukkezen
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Jasper Lukkezen: Utrecht University, Utrecht, CPB Netherlands Bureau for Economic Policy Analysis, The Hague, The Netherlands

No 14-006/VI, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: In standard macroeconomic models, debt sustainability and price level determinacy are achieved when fiscal policy avoids explosive debt and monetary policy controls inflation, irrespective of the relative strengths of each policy stance. We examine how these policy requirements for equilibrium stability and determinacy change in the presence of sovereign risk. An increase in sovereign risk reduces lender's willingness to hold government debt and raises consumption and inflation. Therefore, inflation and debt dynamics are determined jointly. To ensure stable macroeconomic conditions, both the fiscal and monetary stance must shift to offset debt sustainability concerns. We find that the adoption of a deficit target helps alleviate such concerns and raises the scope for macroeconomic stability.

Keywords: Fiscal and monetary policy coordination; equilibrium determinacy and stability; sovereign risk; policy rules (search for similar items in EconPapers)
JEL-codes: E52 E62 E63 (search for similar items in EconPapers)
Date: 2014-01-07
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (4)

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