Working Paper: CEPR ID: DP4001
Authors: Willem H. Buiter
Abstract: This 2003 Institute for Fiscal Studies Lecture addresses two sets of issues relevant to current and prospective future E(M)U members: the consequences of the Stability and Growth Pact for fiscal-financial sustainability and macroeconomic stability, and some risks associated with operational independence of the central bank.The relevance of the second issue is not restricted to E(M)U members. Poor communication, cooperation and coordination between the fiscal and monetary authorities can be costly in two contingencies. The first of these occurs when the central bank?s role as the lender of last resort needs to be backed up by the willingness of the Treasury to recapitalize the central bank, should the need arise. The second contingency occurs when unwanted deflation needs to be prevented or combated, but the central bank?s conventional monetary arsenal is exhausted. Friedman?s helicopter drop of money, a temporary tax cut or transfer payment increase financed through the issuance of base money will always stimulate demand provided it is not expected to be reversed, in present value terms, in the future. In most real-world institutional/legal settings the implementation of a helicopter drop of base money requires coordinated actions by the central bank and Treasury. Central bank independence is unlikely to survive if either or both of these contingencies occur, if there is an ineffective response by the fiscal and monetary authorities and if this is blamed on lack of communication, cooperation or coordination.
Keywords: Central bank independence; Deflation; Fiscal rules; Helicopter money drop; Lender of last resort; Stability and growth pact; Zero bound
JEL Codes: E31; E32; E42; E61; E62; E63; F33; F41; F42; H62; H87
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Operational independence of central banks (E58) | Poor communication and coordination with fiscal authorities (H29) |
| Poor communication and coordination with fiscal authorities (H29) | Ineffective crisis management (H12) |
| Lack of cooperation between treasury and central bank (E58) | Inflationary pressures and undermined economic stability (E31) |
| Rigid fiscal rules of the Stability and Growth Pact (E62) | Limited ability of governments to respond effectively to economic downturns (H19) |
| Limited ability of governments to respond effectively to economic downturns (H19) | Negative impact on fiscal sustainability and macroeconomic stability (E62) |