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The Big Picture of Monetary–Fiscal Interactions

Authors


  • We would like to thank the Australian Research Council for financial support (DP0879638). The usual disclaimer applies.

Jan Libich, School of Economics and Finance, La Trobe University, Melbourne, VIC 3086, Australia. Email: j.libich@latrobe.edu.au

Abstract

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.

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