Monetary
Instrument Problem Revisited: The Role of Fiscal Policy
by
Soyoung
Kim
University of Illinois at Urbana-Champaign
JEL Classification: E63, E52, E31
Keywords:
monetary instrument problem, variance of inflation, fiscal policy,
nominal
government debt, fiscal determination of the price level
Abstract
The
monetary instrument problem is examined in an endowment economy model with
various stochastic disturbances, with minimizing the variance of inflation as
the policy objective. Following current developments in the theory of fiscal
determination of the price level, for different monetary policies, active or
passive fiscal policy is specified to guarantee a unique equilibrium. The
responses of inflation to various structural disturbances in the constant money
growth rate-passive fiscal (the active monetary-passive fiscal regime, or the
conventional regime where Ricardian equivalence and Quantity Theory of Money
hold) and the constant interest rate-active fiscal regime (the passive
monetary-active fiscal regime, or the regime where fiscal policy determines the
price level) are explained based on monetary and fiscal policies’ role in
financing government deficit changes and satisfying the government budget
constraint in each regime, which is different from the explanations of past
research following Poole. One of interesting findings is that an increase in the
steady state real value of nominal government debts (bonds) reduces the variance
of inflation in the passive monetary-active fiscal regime.
Last
updated March 12, 2002 by Linda Huff
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