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

  • Start date: 01 November 2008
  • End date: 31 October 2011

Recent theoretical work examining the ability of monetary and fiscal policies to stabilise economies over the business cycle suggests that monetary policy should, in the short-run, stabilise output and inflation, while fiscal policy be assigned the role of stabilising government debt. This existing work also suggests that optimal fiscal policy should not implement a target for government debt, but that debt should fluctuate in response to shocks. This is clearly at odds with the adoption of debt/deficit targets in a number of countries. This project will explore the extent to which political conflict, particularly in the setting of fiscal policy, could justify the use of debt targets.  The remainder of the project will focus on the finding that there is a limited role for countercyclical fiscal policy unless monetary policy is constrained (eg by joining a monetary union). This project shall consider economies subject to significant additional inefficiencies which the existing theory typically ignores – for example by allowing for a link between stabilisation policy and economic growth and by considering labour market inefficiencies – and will assess whether there is a role for countercyclical fiscal policy in dealing with such distortions.