Disinflation, External Vulnerability, and Fiscal Intransigence: Some Unpleasant Mundellian Arithmetic

May 22, 2017

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Format: Chicago

Evan C Tanner. Disinflation, External Vulnerability, and Fiscal Intransigence: Some Unpleasant Mundellian Arithmetic, (USA: International Monetary Fund, 2017) accessed December 23, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper examines the policy challenges a country faces when it wants to both reduce inflation and maintain a sustainable external position. Mundell’s (1962) policy assignment framework suggests that these two goals may be mutually incompatible unless monetary and fiscal policies are properly coordinated. Unfortunately, if the fiscal authority is unwilling to cooperate—a case of fiscal intransigence—central banks that pursue a disinflation on a ‘go it alone’ basis will cause the country’s external position to further deteriorate. A dynamic analysis shows that if the central bank itself lacks credibility in its inflation goal, it must rely even more on cooperation from the fiscal authority than otherwise. Echoing Sargent and Wallace’s (1981) ‘unpleasant monetarist arithmetic,’ in these circumstances, a ‘go it alone’ policy may successfully stabilize prices and output, but only on a short-term basis.

Subject: External debt, Fiscal consolidation, Fiscal policy, Foreign exchange, Inflation, Inflation targeting, Monetary policy, Prices, Real exchange rates

Keywords: Africa, Assignment Problem, Central bank, Central bank credibility, Debt ratio, Exchange rate, Exchange rate appreciation, Exchange rate depreciation, Exchange rate misalignment, External Vulnerability, Fiscal consolidation, Fiscal policy adjustment, Inflation, Inflation targeting, Monetary policy, Net export deficit, Phillips curve, Real exchange rates, Risk Premium, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2017/118
Stock No:

WPIEA2017118
ISBN:

9781484300640
ISSN:

1018-5941

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