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Monetary-fiscal coordination: when, why and how?

Author

Listed:
  • Saurabh Sharma
  • Ipsita Padhi
  • Sarat Dhal
Abstract
Purpose - This paper aims to revisit the theme of fiscal-monetary coordination in a general equilibrium setup that allows for unconventional monetary policy, monetary policy transmission and developing country characteristics. Design/methodology/approach - This paper uses a calibrated new Keynesian dynamic stochastic general equilibrium (DSGE) model to study fiscal-monetary interaction. Findings - Debt sits at the center of monetary-fiscal interaction. Under high-debt conditions, the inflation-output trade-off rises with an increase in the strictness with which monetary policy targets inflation, undermining the standard prescription of strict inflation targeting. At the same time, the transmission of monetary policy is also impeded, due to which unconventional monetary policy becomes more appropriate. The need for coordination among the policies gets enhanced in the presence of borrowing cost channel. While the presence of borrowing cost channel increases the need for policy coordination regardless of the debt situation, features like higher share of non-Ricardian households and weaker monetary policy transmission affect monetary-fiscal interaction to a greater extent under high-debt environment. Originality/value - First, this paper uses inflation-output trade-off as a metric, to analyze fiscal-monetary interaction. Second, this paper considers the impact of developing country characteristics (such as a higher share of non-Ricardian households, impeded monetary policy transmission and supply constraints/borrowing cost channel) on fiscal-monetary interaction. Third, the DSGE model developed in this paper incorporates open market operations that could shed light on the role of unconventional monetary policy in the presence of high fiscal deficit and debt, which is particularly relevant in the current context of the COVID-19 pandemic. Fourth, the model also permits an investigation into monetary policy transmission under different debt regimes.

Suggested Citation

  • Saurabh Sharma & Ipsita Padhi & Sarat Dhal, 2022. "Monetary-fiscal coordination: when, why and how?," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 40(4), pages 661-686, September.
    • Handle: RePEc:eme:sefpps:sef-10-2021-0462
    DOI: 10.1108/SEF-10-2021-0462
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    More about this item

    Keywords

    Monetary and fiscal policies; Yield curve; General equilibrium; Debt and monetary policy transmission; Developing country; E63; E43; C68; E52; E63; E43; C68; E52;
    All these keywords.

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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