Monetary–fiscal policy interactions and commitment versus discretion in a monetary union

We consider monetary–fiscal policy interactions in a monetary union. If monetary and fiscal authorities have different ideal output and inflation targets, the Nash equilibrium output or inflation or both are beyond the ideal points of all authorities. Leadership of either authority is better. Fiscal discretion entirely negates the advantage of monetary commitment: The optimal monetary rule is equivalent to discretionary leadership of monetary over fiscal policy. Agreement about ideal output and inflation creates a monetary–fiscal symbiosis, yielding the ideal point despite disagreement about the relative weights of the two objectives, for any order of moves, without fiscal co-ordination, and without monetary commitment.     

Monetary–fiscal policy interaction and fiscal inflation: A tale of three countries

We study the impact of the interaction between fiscal and monetary policy on the low-frequency relationship between the fiscal stance and inflation using cross-country data from 1965 to 1999. In a first step, we contrast the monetary–fiscal narrative for Germany, the U.S., and Italy with evidence obtained from simple regression models and a time-varying VAR. We find that the low-frequency relationship between the fiscal stance and inflation is low during periods of an independent central bank and responsible fiscal policy and more pronounced in times of non-responsible fiscal policy and accommodative monetary authorities. In a second step, we use an estimated DSGE model to interpret the low-frequency measure structurally and to illustrate the mechanisms through which fiscal actions affect inflation in the long run. The findings from the DSGE model suggest that switches in the monetary–fiscal policy interaction and accompanying variations in the propagation of structural shocks can well account for changes in the low-frequency relationship between the fiscal stance and inflation.     

Optimal monetary–fiscal policy in the euro area liquidity crisis

We build an euro-area level DSGE model featuring a liquidity shock in the sovereign bonds market to simulate the strong contraction in economic activity observed during the 2008–2009 crisis. In the model, a sudden deterioration of the liquidity property of sovereign bonds is associated with deep recession and deflation. Against this background we characterize optimal monetary and fiscal policy with full commitment. We find that the optimal policy contains three features: (i) the policy rate is lowered until hitting the zero lower bound (ZLB) and then is kept at the ZLB for more periods; (ii) a prolonged central bank’s balance-sheet expansion aimed at restoring the liquidity deteriorated; (iii) a counter-cyclical fiscal stimulus which offsets, to a large extent, the fall in private spending caused by the liquidity shock. Policy regimes involving (i), but not (ii) and (iii), are quite weak in stabilizing output gap and inflation. Monetary policy regimes such as full inflation-targeting or nominal GDP targeting perform remarkably well insofar as they are complemented with an optimally-implemented counter-cyclical fiscal policy. Our results tend to favour the view that, in case of recession, an euro-wide coordinated fiscal policy should supplement the role of the ECB in achieving its primary objective.     

How do financial frictions affect the spending multiplier during a liquidity trap?

We show that credit market imperfections substantially increase the government-spending multiplier when the economy enters a liquidity trap. This finding is explained by the tight association between capital goods and firms? collateral, a relationship that we highlight as the capital-accumulation channel. During a liquidity trap, a government spending expansion reduces the real interest rate, leading to a period of cheap credit. Entrepreneurs use this time to accumulate capital, which persistently improves their balance sheets and reduces their future costs of credit. A public spending expansion can thus encourage private investment, yielding consequently a large spending multiplier. This effect is further reinforced by Fisher?s debt-deflation channel.     

Monetary policy and exchange market pressure–evidence from sub-Saharan Africa

The purpose of this study was to assess the impact of monetary policy on foreign exchange market pressure (EMP) in developing country contexts for some selected countries in sub-Saharan Africa (SSA) and to measure the ability of monetary policy to significantly address currency pressures that arise from trading on the global market. This study was motivated by the fact that most of the SSA countries are developing economies that have negative net export positions and stand to lose significantly from consistently deteriorating foreign exchange position. The study, therefore, employs a dynamic panel model to test the hypothesis that a tighter monetary policy stance lends strength to a currency and vice versa, using 20 SSA economies for the period from 1991 to 2010. This study finds a negative and significant relationship between monetary policy and EMP, implying an easing of EMP in the face of contractionary monetary policy. The findings also point to significant relations between aggregate output, levels of public debt, the current account balance, terms of trade and EMP. Findings of this study have important implications as regards the policy direction on exchange rate and currency management.     

Experimental asset markets with endogenous choice of costly asymmetric information

Asymmetric distribution of information, while omnipresent in real markets, is rarely considered in experimental financial markets. We present results from experiments where subjects endogenously choose between five information levels (four of them costly). We find that (i) uninformed traders earn the highest net returns, while average informed traders always perform worst even when information costs are not considered; (ii) over time traders learn to pick the most advantageous information levels (full information or no information); and (iii) market efficiency decreases with higher information costs. These results are mostly in line with the theoretical predictions of Grossman and Stiglitz (Am. Econ. Rev. 70:393–408, 1980) and provide additional insights that studies with only two information levels cannot deliver.     

Mechanism design with a liquidity constrained buyer: The 2×2 case

This paper studies the implications of buyers' liquidity constraints for the optimal selling strategy. The possibility that a buyer faces a binding liquidity constraint affects the seller's strategy in a nontrivial way. Specifically, when a seller has one unit of a good to sell to a buyer with a quasilinear utility function, the `no-haggling' result indicates that textbook monopoly pricing is optimal, absent liquidity constraints. Introducing a potentially binding liquidity constraint vitiates the no-haggling result, and can make it strictly beneficial for the seller to use nonlinear pricing, to commit to a declining price sequence, or to require the buyer to post a cash bond.     

National numerical fiscal rules: Not complied with,but still effective?

This paper investigates the effects of (non-)compliance with national numerical fiscal rules on fiscal policy in 11 EU member states with 23 fiscal rules in place from 1994 to 2012. Introducing a new dataset of legal texts constituting the fiscal rules, allows a joint empirical analysis of different types and designs of numerical fiscal rules. In various empirical exercises the change in the difference between the exact variable constrained by the fiscal rule and its numerical limit is analysed. Statistics show that countries comply with their fiscal rules only in about 50% of the years. Nevertheless, various econometric exercises demonstrate that the introduction of fiscal rules does significantly change the behaviour of fiscal policy. If countries do not comply with their fiscal rule in the year or forecast before, there is a strong downward tendency of the constrained variable towards the numerical limit. The results show that fiscal rules act as kind of a benchmark for policy makers and the public, and even though they might be complied with only in half of the years, they still tilt fiscal policy towards the numerical limit in times of non-compliance.     

Determinants of compliance with fiscal rules: Misplaced efforts or hidden motivations?

This paper empirically examines which factors have influenced numerical compliance with fiscal rules in Latin American and Caribbean countries over the period 2000 to 2020. We use logistic regression models to associate three groups of specific factors with a greater or lesser probability of compliance with the rule: the macroeconomic and political environment of the countries and the design features of the enforced rules. We find that only changes in the macroeconomic and political context affect the probability of compliance with the enforced rules. In contrast, the institutional design of the fiscal rules does not seem to play an essential role in the compliance outcome. This result suggests that adjustments in this direction are not decisive for rule compliance.     

Better Than the Euro? The European Monetary System (1979–1998)

ABSTRACT

The euro crisis has provoked a debate on the pros and cons of adjustable exchange rate regimes that enable their participants to negotiate nominal de- and revaluations. To evaluate the functioning of such regimes, we revisit the EMU’s predecessor, the European Monetary System (EMS). We show that in the EMS, devaluations did indeed help more than revaluations did hurt. Assuming that the political-economic heterogeneity of the Eurozone will not vanish in the foreseeable future, the move to a more flexible exchange rate regime might therefore be economically advantageous. However, a purely economic view ignores the huge political ‘maintenance costs’ of negotiable realignments, costs that the EMS members aimed at overcoming when they opted for the euro. The re-politicization of nominal exchange rate policy in today’s Eurozone would therefore not end transnational political conflicts in the Eurozone but fuel new ones.     

A segmented trend model to assess fiscal sustainability: The US experience 1929–2009

The academic literature has focused largely on testing for long-run fiscal sustainability. In this exercise we formulate a flexible regression model that can be used to assess the sustainability of a more recent build-up of fiscal deficits and debt that would be of major concern to policy makers. The analysis of US data shows that, after adjusting for some fundamentals, the gross Federal debt–income ratio has been growing at an unsustainable rate of 4 % per year since 2007. The net debt–income ratio does not show such a significant trend. Since not all government assets are readily available to reduce debt, significant positive trends in the gross debt–income ratio calls for policy actions.     

Environmental enforcement when ‘inspectability’ is endogenous: A model with overshooting properties

If a firm can influence its monitorability vis-à-vis an environmental regulator, it is shown that increasing the thoroughness of inspections induces the firm to substitute towards more transparent technologies, whilst increasing their frequency may cause substitution the other way. Perversely, when the effect of such substitution is taken into account, an increase in the frequency of inspections (or, equally, the stringency of penalties) may worsen the firm's environmental performance. The agency should favour more thorough inspections than existing theory suggests, particularly in sectors where the scope for such substitution is great. Moreover, when monitorability adjusts only sluggishly to policy shocks (because it is an embodied characteristic of capital, for example) the environmental impacts of increased frequency and increased thoroughness well over- and under-shoot their respective long-run impacts. In assessing regulatory reform, therefore, it is important to leave sufficient time for the class of adjustments identified to occur. The possibility of overshooting can be used as an alternative to existing regulatory capture theories to explain why the efficacy of some classes of regulatory reform may fade through time.     

Managing Capital Inflows Indirectly? On the Determinants of Monetary Sterilization with Reference to East Asia

This paper derives a time‐varying sterilization coefficient to examine those factors that determine the extent to which central banks might engage in monetary sterilization. There appear to be good reasons to do so: Sterilization neutralizes the monetary impact of reserve accumulation, which is an endogenous consequence of sustained capital inflows under some degree of management of exchange rates. A pooled sample of Asian economies incorporating Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand, for 1994–2012 is employed. We find that this method does help to directly uncover the determinants of sterilization, and while capital inflows do not appear to influence the sterilization directly, there is substantial evidence to suggest it does so indirectly—particularly through domestic interest rates.     

The effect of fiscal performance on local government election results in Israel: 1989–1998

We discuss the circumstances under which voters in local elections will reward fiscal responsibility and suggest that such circumstances evolved in Israel in the mid-1990s. We present empirical evidence that, indeed, fiscal performance of mayors substantially affected their reelection probability in the 1998 campaign but not in the 1989 and 1993 campaigns. Changes in the political environment, enforcement of audit and financial reporting requirements, tougher imposition of hard budget constraints and the development of local media are proposed as explanations. The hypotheses that the fiscal variables reflect the income level at the locality, or the mayor’s success in extracting resources from the central government are tested and rejected.     

Monetary Policy Regime Shifts and Uncovered Interest Parity Revisited: The Euro–US Dollar Exchange Rate

ABSTRACT

To explore possible sources of the well-documented uncovered interest parity (UIP) violation in the foreign exchange market, this paper scrutinizes structural changes in monetary reactions to inflationary pressure in the conventional approaches to nominal exchange rate and examines how this small but important change has an effect on the empirical implications of the UIP condition. In addition to some salient features found in the euro exchange rate, by introducing occasional monetary policy regime shifts into an otherwise standard open-economy dynamic general equilibrium model, we found some important findings that potentially help better understand exchange rate dynamics. During the entire sample period, 1999:M1–2014:M8, exchange rate disconnect puzzle still exists. However, sub-sample analysis suggests that relatively passive monetary reaction implying less frequent intervention by monetary authority tends to be more consistent with the UIP relation. Simulation results support the empirical regularities.     

Kaldorian assumptions and endogenous fluctuations: a note on Schinasi’s IS–LM model

Results on Schinasi’s (Rev Econ Stud 48:649–653, 1981; J Econ Theory 28:369–375, 1982) variant of the dynamic fixed-price IS–LM model have remained so far confined to Kaldorian type economies, namely to those economies which present a greater-than-unity marginal propensity to spend out of income. This paper shows that, in the case of a negative interest rate sensitivity of savings, stable endogenous cycles can actually emerge as equilibrium solutions of the model also in the case of non-Kaldorian type economies.     

Vertical separation with location–price competition

While the literature has generally found that vertical separation helps buffer competition and harm consumers in a duopolistic market, we find the exact opposite. To induce the retailers to locate closer to consumers and earn a larger market share, the manufacturers set wholesale prices below marginal cost. This market share effect dominates the previously focused coordination effect under which a higher wholesale price helps coordinate the retailers’ pricing decisions. For each manufacturer, vertical separation is a dominant strategy so the endogenous determination of vertical separation versus vertical integration is a prisoner’s dilemma game.