Working Paper: NBER ID: w16510
Authors: Eric M. Leeper
Abstract: Monetary policy decisions tend to be based on systematic analysis of alternative policy choices and their associated macroeconomic impacts: this is science. Fiscal policy choices, in contrast, spring from unsystematic speculation, grounded more in politics than economics: this is alchemy. In normal times, fiscal alchemy poses no insurmountable problems for monetary policy because fiscal expectations can be extrapolated from past fiscal behavior. But normal times may be coming to an end: aging populations are causing promised government old-age benefits to grow relentlessly and many governments have no plans for financing the benefits. In this era of fiscal stress, fiscal expectations are unanchored and fiscal alchemy creates unnecessary uncertainty and can undermine the ability of monetary policy to control inflation and influence real economic activity in the usual ways.
Keywords: monetary policy; fiscal policy; macroeconomic stability; fiscal alchemy
JEL Codes: E31; E52; E58; E61; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal expectations (H68) | Monetary policy effectiveness (E52) |
| Active fiscal policy (E62) | Inflation stabilization (E31) |
| Unanchored fiscal expectations (E62) | Inflation control (E64) |