Monetary and Fiscal Policy Interactions: Optimal Delegation and the Value of Leadership

46 Pages Posted: 8 Nov 2006

See all articles by Andrew P. Blake

Andrew P. Blake

Bank of England - CCBS

Tatiana Kirsanova

University of Glasgow - Adam Smith Business School

Date Written: October 2, 2006

Abstract

We consider monetary and fiscal policy interactions in a New-Keynesian model of a closed economy with a government solvency constraint. We study the problem of optimal delegation in the discretionary game with two optimising policymakers and provide a welfare ranking of different leadership regimes. We find that (1) if one policymaker chooses an aggressive (smooth) policy then the other policymaker must also choose an aggressive (smooth) policy, regardless of the leadership regime; (2) an institutional design that causes any policymaker to adopt an aggressive policy generally leads to welfare losses; (3) an institutional design that causes any policymaker to adopt a history-dependent policy is welfare increasing. Specific results obtained include showing that discretionary stabilisation policy by a conservative central bank reduces welfare, and that a 'speed limit' on fiscal policy improves social welfare as the central bank chooses to smooth the interest rate in equilibrium.

Keywords: Monetary and Fiscal Policy, Optimal Delegation, Discretion, Leadership Equilibria

JEL Classification: E31, E52, E58, E61, C61

Suggested Citation

Blake, Andrew P. and Kirsanova, Tatiana, Monetary and Fiscal Policy Interactions: Optimal Delegation and the Value of Leadership (October 2, 2006). Available at SSRN: https://ssrn.com/abstract=943028 or http://dx.doi.org/10.2139/ssrn.943028

Andrew P. Blake

Bank of England - CCBS ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Tatiana Kirsanova (Contact Author)

University of Glasgow - Adam Smith Business School ( email )

Glasgow, Scotland
United Kingdom