The Dire Effects of the Lack of Monetary and Fiscal Coordination

NBER Working Paper No. 23605

Issued in July 2017

NBER Program(s):Economic Fluctuations and Growth, Monetary Economics



What happens if the government's willingness to stabilize a large stock of debt is waning, while the central bank is adamant about preventing a rise in inflation? The large fiscal imbalance brings about inflationary pressures, triggering a monetary tightening, further debt accumulation, and additional inflationary pressure. Thus, the economy will go through a spiral of higher inflation, output contraction, and further debt accumulation. A coordinated commitment to inflate away the portion of debt resulting from a large recession leads to better macroeconomic outcomes by separating the issue of long-run fiscal sustainability from the need for short-run fiscal stabilization. This strategy can also be used to rule out episodes in which the central bank becomes constrained by the zero lower bound.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w23605

Published: Francesco Bianchi & Leonardo Melosi, 2018. "The dire effects of the lack of monetary and fiscal coordination," Journal of Monetary Economics, . citation courtesy of

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