Working Paper: CEPR ID: DP6814
Authors: Matthew B. Canzoneri; Robert Cumby; Behzad Diba; J. David López-Salido
Abstract: It is commonly asserted that monetary and fiscal policy may have to be coordinated if they are to provide a nominal anchor and avoid the pathological outcomes of sunspots or explosive price paths. In this paper, we study a model in which government bonds are an imperfect substitute for money in the transactions technology, providing a new channel for debt dynamics to feed into inflation dynamics. This modification of an otherwise standard NNS model substantially alters the conditions for local determinacy and the requirements for macroeconomic policy coordination: the Taylor Principle is no longer sacrosanct; a weak fiscal response to debt is no longer the panacea for a weak monetary policy; sunspot equilibria may be less relevant than previously thought; and the need for coordination may be less than previously thought. In addition, our model provides a new way of thinking about the structural break that is thought to have occurred around 1980 in monetary policy and in the dynamics of government spending and private consumption.
Keywords: bonds; monetary and fiscal policies; transaction services
JEL Codes: E51; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government bonds provide transactions services (H63) | debt dynamics influence inflation dynamics (E31) |
| government deficits increase effective transactions balances (E62) | affect inflation (E31) |
| debt dynamics influence inflation dynamics (E31) | alters previously accepted view of the Taylor principle (E19) |
| weak fiscal response to debt (E62) | not a sufficient remedy for weak monetary policy (E49) |
| existence of sunspot equilibria (C62) | less relevant than previously thought (B20) |
| need for coordination between monetary and fiscal policies (E61) | diminished (Y60) |
| policy changes (J18) | may need to be coordinated to avoid extremes of sunspot equilibria and explosive behavior (C62) |
| modified model (C59) | offers a new perspective on structural break in monetary policy (C54) |