Working Paper: CEPR ID: DP5464
Authors: Tatiana Kirsanova; Sven Jari Stehn; David Vines
Abstract: This paper studies the interactions of fiscal and monetary policy when they stabilise a single economy against shocks in a dynamic setting. We assume that fiscal and monetary policies both stabilise the economy only by causing changes to aggregate demand. Our findings are as follows. If the both policymakers are benevolent, then the best outcome is achieved when the fiscal authority allows monetary policy to perform nearly all of the burden of stabilising the economy. If the monetary authorities are benevolent, but the fiscal authorities have distorted objectives, then a Nash equilibrium will result in large welfare losses: unilateral efforts by each authority to stabilise the economy will result in a rapid accumulation of public debt. However, if the monetary authorities are benevolent and the fiscal authorities have distorted objectives, but there is a regime of fiscal leadership, then the outcome will be very nearly as good as it is in the regime in which both policymakers are benevolent.
Keywords: Fiscal Policy; Macroeconomic Stabilisation; Monetary Policy
JEL Codes: E52; E61; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cooperation between fiscal and monetary authorities (E63) | Effective economic stabilization (E63) |
| Misalignment of objectives between fiscal and monetary authorities (E61) | Welfare losses and public debt accumulation (H69) |
| Fiscal authority acts as a Stackelberg leader (E62) | Improved stabilization outcomes (E63) |
| Non-cooperative fiscal authority playing Nash (H39) | Harm to social welfare due to excessive discounting and aiming for excess output (H43) |