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Keywords:

  • fiscal-monetary policy interaction;
  • commitment;
  • inflation targeting
  • C70;
  • E61

The paper offers a schematic game theoretic approach to thinking about medium-term strategic interactions between monetary and fiscal policy. We show that under some circumstances fiscal excesses may spill over to monetary policy, but a legislated commitment to a numerical inflation target can sometimes prevent this through providing the central bank with ammunition to counter-act excessive fiscal actions. As such, a more explicit monetary commitment may have a ‘disciplining effect’ on fiscal policy, and improve fiscal outcomes as well as monetary outcomes. We present some empirical evidence for this finding.