Simple Monetary Rules Under Fiscal Dominance

By Michael Kumhof, Ricardo C Nunes, Irina Yakadina

December 1, 2007

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Format: Chicago

Michael Kumhof, Ricardo C Nunes, and Irina Yakadina. Simple Monetary Rules Under Fiscal Dominance, (USA: International Monetary Fund, 2007) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Is aggressive monetary policy response to inflation feasible in countries that suffer from fiscal dominance? We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. However, resulting inflation is extremely volatile and zero lower bound on nominal interest rates is frequently violated. Within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance.

Subject: Expenditure, Fiscal policy, Inflation, Real interest rates, Zero lower bound

Keywords: Interest rate, Lower bound, WP

Publication Details

Pages:

25
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/271
Stock No:

WPIEA2007271
ISBN:

9781451868340
ISSN:

1018-5941

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