Working Paper: CEPR ID: DP16679
Authors: Jean Barthelemy; Eric Mengus; Guillaume Plantin
Abstract: This paper studies a model in which the price level is the outcome of dynamic strategic interactions between a fiscal authority, a monetary authority, and investors in government bonds and reserves. The “unpleasant monetarist arithmetic” whereby aggressive fiscal expansion forces the monetary authority to chicken out and inflate away public liabilities may be contained by market forces: Monetary dominance prevails if such fiscal expansion is met with a higher real interest rate on public liabilities, due for example to the crowding out of private investment opportunities. The model delivers empirical implications regarding the joint dynamics of public liabilities and price level, and policy implications regarding the management of central banks’ balance sheets.
Keywords: Monetary Policy; Fiscal Policy; Price Level
JEL Codes: E31; E52; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal Authority's aggressive debt issuance without commitment (H63) | Monetary Authority inflates away public liabilities (E49) |
| Increased public liabilities (H69) | Real interest rates rise (E43) |
| Increased public liabilities (H69) | Price level (E30) |
| Fiscal expansion (E62) | Monetary dominance (E42) |
| Fiscal authority prefers to increase borrowing (E62) | Price level above monetary authority's target (E49) |
| Private sector expectations (E69) | Equilibrium price level (E30) |