Working Paper: CEPR ID: DP1463
Authors: Matthew B. Canzoneri; Behzad Diba
Abstract: We use a new theory of price determination ? developed by Woodford, Simms and others ? to characterize central bank independence and price stability. If fiscal policy guarantees that the price level is determined independently of government?s present value budget constraint, we can say that the central bank is operating in a monetary dominant regime; it has the ?functional independence? necessary to control the price level independently of the dictates of fiscal solvency (if it so chooses), and it can be held accountable for price stability (if that is its mandate). If fiscal policy does not allow this, we say the central bank is operating in a fiscal dominant regime. Numerical exercises suggest that price stability may be beyond the control of the central bank in such a regime. We show that strict enforcement of the Maastricht Treaty?s deficit criterion would ensure a monetary dominant regime.
Keywords: Central Bank Independence; Monetary Policy; Fiscal Policy; Price Determination
JEL Codes: E3; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal Constraints (H60) | Central Bank Accountability (E58) |
| Primary Surpluses Increase in Response to Rising Government Debt (H62) | Central Bank Independence (E58) |
| Fiscal Shocks (H39) | Price Stability (E31) |
| Monetary Dominant Regime (MD) (E42) | Central Bank Control over Price Level (E64) |
| Fiscal Dominant Regime (FD) (E62) | Central Bank Control Compromised (E58) |
| Strict Enforcement of Deficit Criteria (H62) | Monetary Dominant Regime (MD) (E42) |