Monetary and fiscal policies require coordination to achieve desired macroeconomic outcomes. The literature since Leeper (1991) has focused on two regimes: monetary dominance and fiscal dominance. In both cases, one policy is active while the other is passive and accommodates the former. We study this coordination problem in an international economy, and find a third regime—hegemon dominance. In this case, one country (the hegemon)'s monetary and fiscal authorities can pursue separate policy goals, while the other country's monetary and fiscal policies are both accommodative. For example, the hegemon can pursue a monetary policy unbacked by its fiscal policy. When this happens, the foreign monetary authority has to take the same stance as the hegemon, the foreign fiscal authority has to provide fiscal backing for the monetary stance undertaken by both countries, and the exchange rate adjusts to equilibrate the economy. Our result suggests that the U.S. fiscal policy's independence from its own monetary policy can be made possible by accommodative foreign policies, and that the Fed's effort to fight inflation can succeed despite the high level of public debt which would have required enormous fiscal backing in a closed economy.
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- Acknowledgements & Disclosure
- Zhengyang Jiang gratefully acknowledges the research support from the William and Mary Breen Fund at the Kellogg School of Management, Northwestern University. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w33123
- Pages
- 64
- Published in
- United States of America
Table of Contents
- Introduction 3
- Baseline Model 8
- Households 9
- Firms 10
- Monetary and Fiscal Policies 11
- Equilibrium Conditions 12
- Model Characterization 14
- Active and Passive Policy Rules 18
- leeper1991equilibria Set-up 19
- Introducing New-Keynesian Phillips Curve 22
- Calvo Pricing in Open Economy 23
- Inspecting the Mechanism 26
- Conclusion 31
- Theory Appendix 39
- Derivation of the Baseline Setting 39
- Proof of Proposition 1 46
- Proof of Proposition 2 48
- Proof of Proposition 3 49
- Proof of Proposition 4 50
- Derivation of the Two-Country Calvo Model 51
- Proof of Proposition 5 54
- Proof of Proposition 6 56
- Algebraic Solution of Monetary Dominance in Closed Economy 58
- Model Calibration 62
- Alternative Specification 63
