Budget uncertainty in a monetary union

Governments in a monetary union fear spending disturbances. We distinguish them according to their ability to hedge against these disturbances and assume that they derive their optimal fiscal decisions by using a robust control approach. Results show that governments being highly vulnerable to spending disturbances set excessive tax rates, thereby exacerbating the fiscal pressure detrimental to output and obliging the central bank to conduct an expansionary monetary policy. Countries whose governments have higher ability to hedge against spending disturbances then suffer from the inflationary consequences of this monetary policy.     

CENTRAL BANK INDEPENDENCE AND THE MONETARY INSTRUMENT PROBLEM

We study the monetary instrument problem in a dynamic noncooperative game between separate, discretionary, fiscal and monetary policy makers. We show that monetary instruments are equivalent only if the policy makers' objectives are perfectly aligned; otherwise an instrument problem exists. When the central bank is benevolent while the fiscal authority is short‐sighted relative to the private sector, excessive public spending and debt emerge under a money growth policy but not under an interest rate policy. Despite this property, the interest rate is not necessarily the optimal instrument.     

United we stand: on the macroeconomics of a Fiscal union

In this paper, we apply dynamic tracking games to macroeconomic policy making in a monetary union. We use a small stylized nonlinear two-country macroeconomic model of a monetary union for analyzing the interactions between two fiscal (governments: “core” and “periphery”) and one monetary (central bank) policy makers, assuming different objective functions of these decision makers. Using the OPTGAME algorithm, we calculate numerical solutions for cooperative (Pareto optimal) and non-cooperative games (feedback Nash). We show how the policy makers react to adverse demand shocks. We investigate the consequences of three scenarios: decentralized fiscal policies controlled by independent governments (the present situation), centralized fiscal policy (a fiscal union) with an independent central bank (pure fiscal union), and a fully centralized monetary and fiscal union. For the latter two scenarios, we demonstrate the importance of different assumptions about the joint objective function corresponding to different weights for the two governments in the design of the common fiscal policy. We show that a fiscal union with weights corresponding to the number of states in each of the blocs gives better results than non-cooperative policy making. When one bloc dominates the fiscal union, decentralized policies yield lower overall losses than the pure fiscal union and the monetary and fiscal union.     

RE-EXAMINING THE EFFECTIVENESS OF STABILISATION POLICY

This paper develops an alternative international macroeconomic model for evaluating the effectiveness of fiscal and monetary policy in stabilising national income under fixed and floating exchange rates. It encompasses national output and income, saving, investment, money and capital flows and linkages between the exchange rate, price levels and real interest rates consistent with international parity conditions. It demonstrates that the nature of government spending is pivotal to the effectiveness of fiscal policy, revealing that, ceteris paribus , higher public consumption expenditure contracts national income and depreciates the exchange rate, whereas higher productive public investment spending has opposite effects. The framework also shows that the effectiveness of fiscal and monetary policy as macroeconomic policy instruments is not ultimately dependent on the exchange rate regime.     

INTERACTION BETWEEN MONETARY AND FISCAL AUTHORITIES UNDER INCOMPLETE INFORMATION

This paper analyzes the interaction between monetary and fiscal authorities under incomplete information. The inflation goal of the central bank is assumed to be unknown to the fiscal authority and the public. The central bank signals the goal by choosing the first‐period monetary policy before the fiscal authority joins the policy‐making game. If the central bank would like the fiscal authority and the public to believe that it is wet (dry), the central bank would distort the money supply upward (downward) in order to reveal its actual type.     

The unbearable tightness of being in a monetary union: Fiscal restrictions and regional stability

We study how constrained fiscal policy can affect macroeconomic stability and welfare in a two-region model of a monetary union with sticky prices and distortionary taxation. Both government spending and taxes can be used to stabilize regional variables; however, the best welfare outcome is obtained under some tax variability and constant regional inflations. We use a variety of rules to characterize constrained fiscal policy and find that strict fiscal rules coupled with a monetary policy that targets union-wide inflation result in regional inflation stability and the welfare costs of such rules are not as unbearable as one would expect. Fiscal authorities can enhance welfare by targeting the regional output gap, while targeting regional inflation is less successful since inflation stability is guaranteed by the central bank.     

Monetary and fiscal policy interactions in a post Keynesian open-economy model

Using a post Keynesian model, this study aims to analyze the stabilizing role of fiscal and monetary policies in an open economy with a managed exchange rate regime. The real exchange rate is modeled as an endogenous variable and inflation explained using the conflicting claims approach. The dynamic properties of macroeconomic equilibrium are evaluated in different regimes of fiscal and monetary policies. The main result of this study suggests that the preferred policy regime is the one in which economic authorities are complementary and fiscal policy plays an explicitly active role. In this regime, the fiscal policy must commit to the target for the rate of capacity utilization and the monetary authority must commit to the inflation target.     

Inflation and the fiscal limit

We use a rational expectations framework to assess the implications of rising debt in an environment with a “fiscal limit”. The fiscal limit is defined as the point where the government no longer has the ability to finance higher debt levels by increasing taxes, so either an adjustment to fiscal spending or monetary policy must occur to stabilize debt. We give households a joint probability distribution over the various policy adjustments that may occur, as well as over the timing of when the fiscal limit is hit. One policy option that stabilizes debt is a passive monetary policy, which generates a burst of inflation that devalues the existing nominal debt stock. The probability of this outcome places upward pressure on inflation expectations and poses a substantial challenge to a central bank pursuing an inflation target. The distribution of outcomes for the path of future inflation has a fat right tail, revealing that only a small set of outcomes imply dire inflationary scenarios. Avoiding these scenarios, however, requires the fiscal authority to renege on some share of future promised transfers.     

Monetary policy,fiscal policy and cross signal jamming

This paper considers the issue of rule versus discretion when the central bank and the government share private information but have different preferences over inflation and output. We demonstrate that if the monetary policy is rule-based, Intuitive Criterion selects the unique separating equilibrium in which the central bank signals a low supply shock by a low interest rate. Interestingly, discretion may be better than the rule for the central bank, contrary to the case of complete information. Also, we examine the effect of information asymmetry on the monetary and fiscal policy mix. We show that cross signal jamming whereby the monetary authority and the fiscal authority successfully jams an unfavorable signal of each other does not occur in equilibrium.     

Capital control reconsidered: financialisation and economic policy

We consider capital controls and their impact on selected countries, providing a critique of IMF policy. We show how the warning signs of the 1970s were ignored and the consequences became apparent during the ensuing period of neoliberal hegemony. We contend that promoting increased capital mobility is counterproductive as it reduces macroeconomic ‘policy space’. We introduce a development of the international policy ‘trilemma’ in the form of a variant of the idea of the ‘quadrilemma’. We suggest that, in most cases, the key policy driving economic growth is fiscal policy but it may be that its unconstrained use (and that of monetary policy) is not possible either under fixed exchange rates or when free capital mobility exists; a nation may face a ‘demi-quadrilemma’. We contend that, in practice, a country can only adopt ‘two from four’; if it chooses to retain free use of monetary and fiscal policy, it must sacrifice both fixed exchange rates and capital mobility. We advocate the rejection of fixed exchange rates and free capital mobility allowing the retention of requisite monetary and fiscal policy space, and that a multinational approach to the capital control policy would effectively contribute to a growth and development strategy.     

Monetary and Fiscal Policy Rules in the EMU

Abstract. This paper studies the design and effects of monetary and fiscal policy in the euro area. To do so, a stylized two‐region model of monetary and fiscal policy rules in the EMU is built. We analyse how monetary and fiscal rules affect the adjustment dynamics in the model. Both the effects on the individual countries and on the EMU aggregate economy are studied. Three aspects play an important role in the analysis: (i) the consequences of alternative monetary and fiscal policy rules, (ii) the consequences of asymmetries between EMU countries (asymmetries in macroeconomic shocks and macroeconomic structures), and (iii) the role of alternative degrees of backward‐ and forward‐looking behaviour in consumer decisions and inflation expectations.     

The government's time discount rate: Choices and consequences in a dynamic framework

This paper considers a closed macroeconomy where the monetary authority pursues an inflation target and policy outcomes are the consequence of a Nash game between fiscal and monetary authorities. The specification of the macroeconomic framework is characterized by nonlinearities which lead to multiple equilibria with differing stability properties. Employing a calibrated model and simulations derived using the Mathematica package, the stability properties of the economy and the likely choice of equilibrium are examined. Within this framework, the dynamic consequences of different time discount rates for the fiscal authority are investigated, both in a world of certainty and also in a world of uncertainty. It is shown that, in a world of certainty, it will be optimal to choose the fiscal authority's time discount rate equal to the market rate of interest. However, depending on the degree of uncertainty in evaluating the time discount rates of consumers and of the fiscal authority, it may be appropriate to bias the fiscal authority's discount rate above or below the expected interest rate.     

Monetary and fiscal policy transmission in Poland

This paper combines a fiscal structural vector-autoregression (SVAR) with a monetary SVAR for the Polish transition economy. Data are constructed from scratch in order to account for features of the transition economy and for delays in implementing legislated government spending and tax changes (fiscal foresight). For monetary policy, we find no price puzzles in the combined SVAR. Also, fiscal foresight variables have no statistically significant effects. We calculate an initial government spending multiplier of 0.70, which later peaks at 1.61 for the cumulative multiplier. This multiplier is much larger than multipliers estimated in previous studies not combining fiscal and monetary policy, where they were found to be close to zero. On the other hand, the tax multiplier is generally near zero in our study. We demonstrate the importance of combining fiscal and monetary transmission mechanisms when assessing the effects of government macroeconomic policies.     

Fiscal and monetary interactions when wage-setters are large: is there a role for corporatist policies?

This paper studies the macroeconomic consequences of alternative policy regimes in a closed economy where a central bank, a fiscal authority and a monopoly union interact via their effects on output and inflation. The analysis compares macroeconomic outcomes in a non-cooperative setting, where players may move sequentially or simultaneously, and in a regime of cooperation between the government and wage-setters. The cooperative regime captures a climate of accord among social parties that is finalised at common macroeconomic targets in the tradition of corporatism, as in the recent experience of “social pacts” in many European countries. The paper makes two main contributions. First, it shows that macroeconomic outcomes are suboptimal in the non-cooperative regime and may deliver extreme (undesirable) results even when all players share common ideal targets for output and inflation. All players would be better off with a less extreme value for output or inflation, yet they fail to reach a more advantageous allocation as long as there is an inherent conflict among their further objectives. Moreover, the result is robust to a change in the degree of central bank’s conservatism. Second, I find that cooperation between the government and the monopoly union towards common ideal targets for inflation, output and taxes enhances social welfare even in the absence of explicit coordination with the central bank.     

Central bank independence,fiscal deficits and currency union: Lessons from Africa

Can central bank independence (CBI) help to reduce fiscal balances? In this paper, we answer this question using novel measures of CBI based on the turnover rate of central bank governors (TOR) and the Garriga measure of legal independence for 30 African countries for the period 1990–2017. Our novel measures of CBI capture the degree of alliance between the fiscal authority and the monetary authority which can potentially lead to debt monetization and higher fiscal balances. Thus, we classify central bank governor changes into ally changes or non-ally changes; in addition to that, we decompose our full sample into CFA zone countries and non-CFA zone countries to capture the effect of currency union membership. Our results show that for CFA zone countries, central bank autonomy, when proxied by the turnover rate of central bank governors, is associated with a decrease in fiscal balances and replacing a central banker with a non-ally, is negatively and significantly associated with fiscal balances.     

“Core” and “Periphery” in a Monetary Union: A Macroeconomic Policy Game

We develop a dynamic game model of a two-country monetary union to study strategic interactions between macroeconomic policy makers, namely the central bank and governments. In this union, the governments of participating countries pursue national goals when deciding on fiscal policies, whereas the common central bank’s monetary policy aims at union-wide objective variables. The union considered is asymmetric, consisting of a core, with lower initial public debt, and a periphery, with higher initial public debt. For a symmetric demand shock, we derive numerical solutions of the dynamic game between the governments and the central bank using the OPTGAME algorithm. We show that mildly active cooperative countercyclical policies dominate noncooperative solutions and a scenario of no policy intervention. Optimal policies call for a brief expansionary action to bolster the effects on output and a return to a small fiscal primary surplus as soon as the crisis is over until the targeted level of public debt is reached.     

Fiscal Transfers in a Monetary Union with Exit Option

It is widely debated whether a monetary union has to be accompanied by a fiscal transfer scheme to accommodate asymmetric shocks. We build a model of a monetary union with a central bank and two heterogeneous countries that are linked by a fiscal transfer scheme with repercussions on monetary policy. A central bank aiming at securing the existence of a monetary union in the presence of asymmetric shocks has to compensate single countries for the tax distortions arising from fiscal transfers. Monetary policy may become more expansionary or restrictive depending on asymmetries between member countries' inflation aversion and exit costs.     

An independent central bank faced with elected governments

The literature argues that the benefits of an independent central bank accrue at no cost to the real side. In this paper, we argue that the lack of correlation between monetary autonomy and output variability is due to the proactive role of fiscal policy when faced with rigid monetary objectives. Few of the attempts to measure these correlations actually allow for a changing fiscal role. Yet, when an independent authority handles monetary policy, fiscal and wage/social protection policies remain instruments in the hands of elected governments. We find that, so long as the two authorities pursue their goals independently of each other, a conflict arises that becomes stronger as preferences diverge. We also find that the establishment of a conservative central bank encourages more divergent preferences among the public (as reflected in the government that is elected). The election of more interventionist governments then makes it harder for either authority to reach its own preferred objectives, unless cooperation is possible.     

Foreign Exchange Controls and the Parallel Market Premium

This paper studies the relationship between the official and parallel exchange rates, using cointegration, Granger causality, and reduced form methods on data from three Caribbean countries, Jamaica, Guyana, and Trinidad & Tobago, for the period 1985–93. Where the central bank follows a passive policy of infrequent and large adjustments to the official rate, changes in the official rate Granger causes changes in the parallel rate, and larger disparities prevail between the two rates. Foreign exchange controls, expansionary fiscal and monetary policy, and changes of government mostly have a positive effect on the parallel market premium, with foreign exchange controls exerting the strongest impact.     

Overturning Mundell: Fiscal Policy in a Monetary Union

Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell (1961) : a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.
This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.