Discussion Paper Details

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Title: The Dire Effects of the Lack of Monetary and Fiscal Coordination

Author(s): Francesco Bianchi and Leonardo Melosi

Publication Date: July 2017

Keyword(s): coordination, emergency budget, liquidity traps, Markov-switching models and Monetary and ?scal policies

Programme Area(s): International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: 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.

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Bibliographic Reference

Bianchi, F and Melosi, L. 2017. 'The Dire Effects of the Lack of Monetary and Fiscal Coordination'. London, Centre for Economic Policy Research.