Marching to Different Drummers: Coordination and Independence in Monetary and Fiscal Policies

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Discussion Paper

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Most countries have recently experienced high fiscal deficits and real interest rates that depressed national saving and slowed economic growth. This study analyzes the reasons that underlie the skewed fiscal-monetary mix. The first section develops a game-theoretic model of fiscal and monetary coordination and shows that the macroeconomic outcomes depend upon the degree of coordination or independence. The second section applies this approach to the Clinton package by using three macroeconomic models to estimate the likely macroeconomic impacts of different degrees of coordination. The paper concludes that an uncoordinated policy may lead to substantial loss of output that will not be offset by higher potential output growth for many years. This implies that the potential gains from coordination are extremely high.

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