Course Detail

The course aims to provide some of the background necessary to understand and conduct research at the frontier of monetary-fiscal policy interactions. Although much research studies monetary policy in isolation from fiscal policy, and vice versa, doing so implicitly imposes strong maintained assumptions on policy behaviour that may not hold in practice. When those assumptions do not hold, the resulting equilibria can look very different. The course uses a variety of dynamic stochastic general equilibrium models to develop the economic reasoning behind this logic. Models will range from simple "toy" models whose solutions can be derived analytically to more complex models that must be solved numerically.

Even the briefest of reflection on recent economic developments around the world makes it clear why, more than ever, it is essential to study monetary and fiscal policies jointly. So-called "unconventional" monetary policy operations that many central banks undertook are, in fact, fiscal policy in the sense that the assets the central banks acquired are ultimately backed by the government's taxing authority. In addition, many governments implemented substantial fiscal stimulus plans in response to the worldwide recession. Those plans, coupled with aging populations in many advanced economies, portend substantial fiscal stress in the future.

Fiscal stress can undermine the ability of central banks---even inflation targeting central banks that are firmly committed to achieving their targets---to control inflation and to anchor inflation expectations. One well-understood mechanism is Sargent and Wallace's "Unpleasant Arithmetic:" if net-of-interest surpluses do not adjust to back the value of debt, then money creation must do the adjusting. Many economists regard this outcome as relevant only to hyperinflations in countries that do not have the institutions in place to prevent the central bank from caving into fiscal pressures. According to this reasoning, an independent central bank with a mandate of price stability ensures the Sargent-Wallace outcome will not occur.

But Unpleasant Arithmetic is only one mechanism by which fiscal stress can produce inflation. Most government debt is denominated in nominal terms, as in the country's domestic currency. And debt is priced like equities: it derives its value from the expected discounted streams of surpluses and seigniorage. Like equities, the price of debt can adjust to absorb expected fluctuations in those expected streams. News about lower future surpluses reduces the expected backing of debt and, therefore, reduces the value of debt today. Debt's value can fall either because the current price level jumps, reducing the real value of outstanding debt, or because the price of bonds declines (or some combination of the two). Lower bond prices, in turn, raise expected inflation, spreading out the inflation consequences and propagating the effects of news over time.

Whereas Sargent and Wallace's mechanism leads to high and growing inflation, the second mechanism---sometimes called the "fiscal theory"---need not generate high or even especially volatile inflation. The fiscal theory mechanism does, however, imply that inflation is no longer under the control of the central bank.

Under what conditions might the fiscal theory mechanism become operative? What kind of fiscal behaviour is necessary for the central bank to successfully target inflation? Are there observable implications that distinguish between these two ways that fiscal policy can be inflationary? How do policy interactions change when fiscal instruments distort behaviour? If monetary and fiscal policies undergo periodic shifts in the rules they obey, how do equilibria change? How do monetary and fiscal policies interact in open economies or in a monetary union? How can we model and analyze the uncertainty intrinsic to future monetary and fiscal behaviour?

The course consists of several distinct, but interconnected lectures:

The objectives of the conference are:

1. to present state-of-the-art international research on major issues regarding the new macro-prudential supervisory and regulatory approach;
2. to provide a forum for debate among market participants, policy makers and researchers.

Keynote speakers:
Gertrude Tumpel-Gugerell (European Central Bank)
John Geanakoplos (Yale University)
Anil Kashyap (University of Chicago)

Topics

1. Macro-financial models linking financial stability and the performance of the economy:
-introducing widespread financial instability in macroeconomic models
-Making finance models of instability more aggregate
-Transmission channels of financial instability considering the two-way interaction between the financial sector and the economy at large
-Role of non-linearities, feedback and confidence effects

2. Models and tools for the early identification and assessment of systemic risk:
-Role of macro-prudential early warning indicators
-Identification of the best early indicators of widespread imbalances, asset price bubbles, credit booms and over-indebtedness
-Aggregation of different indicators
-Major advances in macro stress testing models
-Analyses of the systemic relevance of non-bank financial intermediaries
-Defining and measuring systemic risk

Financial frictions explain both the value added and the occasional failures of financial markets. Information asymmetries, agency problems, search costs, financial constraints and coordination problems provide reasons why finance is substantially more than a veil over the real economy, and can have influence on the growth prospects and business cycles in developed and emerging countries. Previous and recent financial crises have also underlined that these frictions influence relationships no just between intermediaries and borrowers but extend to interactions among the intermediaries themselves, raising important questions on the optimal regulation and policy frameworks countries should provide. The goal of the conference is to invite policy relevant theoretical and empirical academic contributions and bring together academic economists and central bank researchers to discuss these issues.