Working Paper: CEPR ID: DP534
Authors: Patrizio Tirelli; David Vines
Abstract: The paper evaluates some proposals for macroeconomic stabilization in an open economy, which take the form of simple rules. The first rule assigns monetary policy to inflation control and does not require fiscal intervention. The second rule adds fiscal control of a foreign wealth target to the first assignment. In the third proposal the fiscal instrument is assigned to the internal objective and monetary policy controls foreign wealth. The fourth rule differs from the third in that monetary policy stabilizes the exchange rate at its target zone level. Our analysis shows that control rules for open economy models (which include the current account) might be unstable because of the cumulation of debt service obligations, and that the inclusion of fiscal feedback can prevent such instability.
Keywords: simple rules; monetary policy; fiscal policy; inflation control; current account balance; exchange rates
JEL Codes: 311; 321; 431
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetarist rule (E60) | instability (C62) |
| monetarist rule (E60) | uncontrolled transfers of foreign wealth (H87) |
| uncontrolled transfers of foreign wealth (H87) | instability (C62) |
| reversed assignment (Y40) | enhanced stability (L15) |
| Mundell assignment (F16) | reduced exchange rate fluctuations (F31) |
| target zones proposal (R38) | more stable economic environment (E60) |