Welfare Improving Coordination Of Fiscal And Monetary Policy
Source: Charles University
Should independent monetary and fiscal policies coordinate their actions and/or targets? To examine this question the paper considers a simple reduced-form model in which monetary and fiscal policies are formally independent, but still interdependent - through their mutual spillovers. The analysis shows that the medium-run equilibrium levels of inflation, deficit, and output depend on the two policies' potency (elasticity of output with respect to the policy instruments), ambition (the level of their output target), and conservatism (inflation vs. output volatility aversion). What matters is however the relative degrees of these characteristics across the two policies rather than the absolute degrees for each policy.