Monetary Commitment and Fiscal Discretion: The Optimal Policy Mix

Abstract

We study a noncooperative policy game between monetary and fiscal policy, where only monetary policy can commit to future actions. The equilibrium outcome of the game depends on the strategies available to the monetary policymaker. If strategies are left unrestricted, the central bank can alter the incentives of the fiscal authority in a way that replicates the full commitment solution. If the central bank cannot commit to respond to fiscal policy, the fiscal authority generates fluctuations in government expenditure that undermine the stabilization goals of the central bank. (JEL E12, E23, E31, E52, E58, E62)

Looking Beyond the Trap: Fiscal Legacy and Central Bank Independence*

“…Some contributions, such as (Dixit and Lambertini, 2003; Adam and Billi, 2008; Blake and Kirsanova, 2011), have focused on the gains of appointing a conservative central bank when the lack of coordination generates policy biases. Gnocchi (2013), and more recently Camous and Matveev (2023), have introduced asymmetry of commitment into a non‐cooperative game to examine the welfare gains from appointing a central bank that disciplines the fiscal authority. Camous and Matveev (2023) find that precommitting to a strategic rule can help the central bank to mitigate inflationary and fiscal biases away from the ZLB and can improve price stability and welfare.…”

The Central Bank Strikes Back! Credibility of Monetary Policy under Fiscal Influence

“…The institutional set-up features asymmetric commitment, in the sense that only the central bank has the ability to commit and respond to fiscal policy. 8 This approach is followed by Gnocchi (2013) and Gnocchi and Lambertini (2016): fiscal contingent monetary strategies clearly welfare-dominate restricted ones. Our focus is different and novel.…”