Working Paper: CEPR ID: DP1842
Authors: Maria Demertzis; Andrew Hughes Hallett; Nicola Viegi
Abstract: Most of the literature on the independence of the Central Bank assumes only one policy instrument is available: monetary policy. If we introduce fiscal policy as well, when preferences may differ among policy-makers, the situation is radically different. In this case fiscal policy will weaken substantially the impact of the Central Bank?s actions, and may annihilate them altogether. The Stability Pact may then be a liability, instead of an asset, because it renders both policies impotent (even if credible). We examine whether there is any incentive to retain monetary policy independence; and whether accountability can and should be used to ensure fiscal and monetary policies support each other, rather than destroy each other.
Keywords: Fiscal-Monetary Interactions; Cooperation; Incentives for Independence; Asymmetries; Monetary Union
JEL Codes: E52; E63; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy (E62) | Monetary policy effectiveness (E52) |
| Accountability mechanisms (G38) | Coordination of policy goals (E61) |
| Coordination of policy goals (E61) | Stabilization of inflation and output (E63) |
| Accountability mechanisms (G38) | Economic performance (P17) |
| Fiscal policy preferences diverging from central bank preferences (E62) | Monetary policy effectiveness (E52) |