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THE MACROECONOMIC IMPACT OF MONETARY-FISCAL POLICY IN A “FISCAL DOMINANCE” WORLD

Published online by Cambridge University Press:  02 August 2018

Pengfei Jia
Pengfei Jia*
Affiliation:
Nanjing University
*
Address correspondence to: Pengfei Jia, School of Economics, Nanjing University, 22nd Hankou Road, Gulou District, Nanjing, 210093, China; e-mail: pengfei@nju.edu.cn
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Abstract

This paper focuses on the question of what monetary and fiscal policy can do and should do in a “fiscal dominance” world. I first highlight that both “amplification” and “fiscal cushion” effects are always at work jointly in determining the evolution of inflation. I find the threshold of maturity of government bonds beyond which more aggressive monetary policy dampens inflation volatility is three quarters. In addition, I conduct welfare analysis to quantitatively evaluate the costs and benefits brought by long-term debt. My results show that the threshold of government debt maturity above which an aggressive monetary policy improves welfare is eight quarters. More importantly, I characterize optimal monetary and fiscal policy using simple and implementable rules. My results indicate an optimal monetary and fiscal combination calls for an aggressive response in both rules. Finally, I find that optimized simple monetary-fiscal rule is significantly welfare inferior to the Ramsey optimal policy.

Keywords

Fiscal Theory of the Price Level (FTPL)Optimal Monetary and Fiscal PolicyLong-Term Government Debt
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 3 , April 2020 , pp. 670 - 707
Copyright
© Cambridge University Press 2018

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Footnotes

For useful comments and discussions, I am grateful to Michele Berardi, Christoph Himmels, Hao Jin, Bing Li, Bing Tong, Liang Zhao, and seminar participants at Nanjing University, Xi’an Jiao Tong University, and Nanjing University of Finance and Economics. I also thank the editor, an associate editor, and one anonymous referee for many helpful comments. The views expressed in this paper and any errors are my own.

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