DP6814 Monetary and Fiscal Policy Coordination when Bonds Provide Transactions Services

Author(s): Matthew B Canzoneri , Robert Cumby , Behzad Diba , J David López-Salido

Publication Date: May 2008

Keyword(s): Bonds , Monetary and Fiscal Policies , Transaction Services

JEL(s): E51 , E52

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6814.asp.asp

It is commonly asserted that monetary and fiscal policy may have to be coordinated if they are to provide a nominal anchor and avoid the pathological outcomes of sunspots or explosive price paths. In this paper, we study a model in which government bonds are an imperfect substitute for money in the transactions technology, providing a new channel for debt dynamics to feed into inflation dynamics. This modification of an otherwise standard NNS model substantially alters the conditions for local determinacy and the requirements for macroeconomic policy coordination: the Taylor Principle is no longer sacrosanct; a weak fiscal response to debt is no longer the panacea for a weak monetary policy; sunspot equilibria may be less relevant than previously thought; and the need for coordination may be less than previously thought. In addition, our model provides a new way of thinking about the structural break that is thought to have occurred around 1980 in monetary policy and in the dynamics of government spending and private consumption.