Monetary Exit Strategy and Fiscal Spillovers

CAMA Working Paper Series 04/2011

18 Pages Posted: 21 Feb 2011

See all articles by Jan Libich

Jan Libich

La Trobe University - Business School

Dat Thanh Nguyen

La Trobe University

Petr Stehlík

University of West Bohemia

Multiple version iconThere are 2 versions of this paper

Date Written: February 21, 2011

Abstract

The paper models strategic monetary-fiscal interactions in the aftermath of the global financial crisis – in a single country as well as a monetary union. It depicts both the short-term (stabilization) perspective and the long-term (sustainability) perspective, and the link between them. This is done in a game theoretic framework that allows for revisions of actions, deterministic or stochastic. In addition, we consider incomplete information about economic conditions, and different types of government. We find that, under ambitious fiscal policies, a legislated long-term monetary commitment may: (i) reduce the risk of a double-dip recession and deflation in the short-term, and at the same time (ii) facilitate the 'exit strategy' of monetary policy, prevent sub-optimally high future inflation caused by fiscal spillovers. Our analysis thus implies that an explicit numerical target for average inflation may play the role of a monetary 'credibility insurance' over all phases of the business cycle, and is beneficial especially in countries facing fiscal stress.

Keywords: Monetary-Fiscal Interactions, Game of Chicken, Asynchronous Moves, Stochastic Timing, Equilibrium Selection

JEL Classification: E52, C70

Suggested Citation

Libich, Jan and Nguyen, Dat Thanh and Stehlík, Petr, Monetary Exit Strategy and Fiscal Spillovers (February 21, 2011). CAMA Working Paper Series 04/2011, Available at SSRN: https://ssrn.com/abstract=1766117 or http://dx.doi.org/10.2139/ssrn.1766117

Jan Libich (Contact Author)

La Trobe University - Business School ( email )

La Trobe University
Bundoora, Victoria, Victoria 3083
Australia

Dat Thanh Nguyen

La Trobe University ( email )

Department of Economics and Finance
Victoria 3552, 3086
Australia

Petr Stehlík

University of West Bohemia ( email )

Západoèeská univerzita v Plzni
Fakulta právnická, Sady Pìtatøicátníkù 14
Plzeò, 306 14
Czech Republic

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