Strategic InteractionStrategic Interactionbetween Fiscal and Monetary Policiesbetween Fiscal and Monetary Policies

in an Export-Oriented Economyin an Export-Oriented Economy

Sergey Merzlyakov

Junior Research Fellow of the Laboratory for Macroeconomic AnalysisNational Research University Higher School of Economics, Moscow

Motivation

Literature on Fiscal and Monetary Policy Interaction

Model

Strategic Interaction

Conclusion

Contents

Motivation

Why strategic interaction? Complementary policy instruments Joint constraint

Peculiarity of macroeconomic development in an export-oriented economy

Optimal macroeconomic policy design Central bank independence: do we really need it?

Fiscal and monetary policy interaction: Christ (1979), Sargent and Wallace (1981), Blinder (1982)

Strategic complementarity instruments: Andersen and Schneider (1986), Dixit and Lambertini (2003)

New political economy in macroeconomics setup: Drazen (2000), Persson and Tabellini (2000)

Literature review

Two-period modelKey points

Endogenous variables:

Predetermined variables: all variables in period 0

Policy variables:

1111111 ,,,,,, zsMY E

1, ex

Fiscal policy Discretionary policy (lump-sum taxes, government expenditure) Automatic stabilizers (taxes that depend on export and output) Stabilization fund (as the sterilization mechanism of excessive money)

Monetary policy The only transmission monetary channel is foreign currency

operations Exchange rate target

Export and import depend on exchange rate By changing the international reserves,

the central bank changes the supply of money

Phillips Curve

Aggregate Demand

Government Budget Constraint

Balance of Payment

Foreign Exchange Market Operations

Real Exchange Rate

Money in Circulation

111 YPxVM E

01*

101 YY

000001 PxtYExEss

01000 Im zzCFEx

10101 EzzMM

010101 EE MMssMM

111 PE

Model

2

121

212

1YYeL YSeSS Social Loss Function

Forms of strategic interaction

The government loss:

The central bank loss: 2

121

212

1YYeL YMeMM

2

122

12

1YYxxL YFxFF

Dependent central bank: fiscal and monetary policy coordination

Independent central bank: Stackelberg interaction with the government leadership Cournot interaction (central bank and government do not take each

others’ actions into account when choosing their policies)

What is the optimal bargaining power of the government relative to the central bank?

Coordination: the loss function

221

2

1211

2

1xxeYYL XFeMYFYMMF

Coordination is effective only if the bargaining power of the central bank is relatively large

Coordination: the bargaining power

0,000118 0,005045 0,010

0,099

0,986

0,0

0,2

0,4

0,6

0,8

1,0

1,2

0,01 0,5 1 10 100

Bargaining power

0,00000

0,00002

0,00004

0,00006

0,00008

0,00010

0,00012

0,00014

0,00016

0,00018

0,00020

Government and central bank loss Social loss

Agents’ losses are sensitive to fiscal policy

Central bank independence:agents’ losses

0,00000

0,00005

0,00010

0,00015

0,00020

0,00025

0,00030

0,00035

alphaYF

Lm 0,000223 0,000195 0,000092 0,000076 0,000062 0,000043 0,000022

Lf 0,000005 0,000012 0,000103 0,000123 0,000154 0,000193 0,000303

Ls 0,000166 0,000146 0,000070 0,000059 0,000048 0,000035 0,000019

0 0,05 0,75 1 1,5 2,5 10

Conclusion In an export-oriented economy the independence of the central

bank does not play a significant role

Coordination is preferable if the bargaining power of the central bank is relatively large

Interaction with the government leadership is preferable if the output is government priority

Next: to compare different monetary policy regimes (exchange rate target vs. growth rate of money target), to analyze other forms of strategic interaction (the central bank leadership)

Thank you for your attention!