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New Directions in Monetary and Fiscal Policy Analysis at the Macroeconomic Level

Grant reference: RES-062-23-1436

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Stabilization versus sustainability : macroeconomic policy tradeoffs
Worldwide monetary and fiscal policies in the past few years have put into sharp relief the fundamental tradeoff between short-run stabilization and long-run sustainability that policymakers face. The paper is organized around this question: How do the effects of routine monetary and fiscal operations designed to achieve macroeconomic stabilization objectives change when the economy moves from a debt-GDP level where the probability of default is nil to a higher level—the “fiscal limit”—where that default probability is non-negligible? Three main results emerge. First, when the economy is near its fiscal limit a transitory monetary policy contraction reduces output more, and it reduces inflation only in the very short run, before leading to a sustained rise in inflation in the medium term. Second, higher government spending may be appreciably more inflationary when the economy is staring at its fiscal limit. These effects arise even though monetary policy actively target inflation and fiscal policy passively adjusts taxes to stabilize debt. Third, specification of the central bank’s instrument—risky versus risk-free short-term nominal interest rate—matters for the link between expected default rates and inflation.
http://www.gla.ac.uk/media/media_188323_en.pdf
English

Primary contributor

Author Huixin Bi

Additional contributors

Co-author Eric Leeper
Co-author Campbell Leith

Additional details

University of Glasgow
19 November 2010
40
Glasgow

Files

Bi_stabilization.pdf (.pdf / 336kb)

Cite this outcome

Harvard

Bi, Huixin et al (2010) Stabilization versus sustainability : macroeconomic policy tradeoffs. Glasgow: University of Glasgow.

Vancouver

Bi Huixin et al. Stabilization versus sustainability : macroeconomic policy tradeoffs. Glasgow: University of Glasgow, 2010.