The Monetary-Fiscal Nexus with Ultra Low Interest Rates
Tuesday, Jan. 5, 2021 3:45 PM - 5:45 PM (EST)
- Chair: John Williams, Federal Reserve Bank of New York
Shotgun Wedding: Fiscal and Monetary Policy
AbstractThis paper describes interactions between monetary and fiscal policies that affect equilibrium price levels and interest rates by critically surveying theories about (a) optimal anticipated inflation, (b) optimal unanticipated inflation, and (c) conditions that secure a “nominal anchor” in the sense of a unique price level path. We contrast incomplete theories whose inputs are budget-feasible sequences of government issued bonds and money with complete theories whose inputs are bond-money strategies described as sequences of functions that map time t histories into time t government actions. We cite historical episodes that conform the theoretical insight that lines of authority between a Treasury and a Central Bank can be ambiguous, obscure, and fragile.
The constraint on public debt when r < g but g < m
AbstractSince real interest rates have been well below the growth rate of the economy, but the marginal product of capital has remained above, modern economies are dynamically efficient, yet there is a bubble component in public debt. Thus, the present value of primary surpluses can be lower than the outstanding debt and governments can run perpetual deficits by collecting the bubble premia. Yet, there is an upper bound on the size of the deficits that depends on how safe and liquid government debt is and on financial development. Higher spending lowers the interest rate and increases inequality, while redistributive policies shrink the feasible amount of persistent public spending, income tax cuts pay for themselves, inflation volatility reduces fiscal space available for spending, and financial repression increases it.
Fiscal-Monetary Interactions in a Low Rate World
AbstractWe use a semi-structural model of the US and the euro area economy to analyse fiscal-monetary interactions when interest rates are very low. The model features conventional monetary policy conducted through the short-term interest rate, central bank balance sheet policies conducted through asset purchases, fiscal policy in the form of a primary deficit rule and government debt accumulation. The analysis focuses on robustness with respect to natural rate uncertainty, the formation of inflation expectations and the uncertain effect of the balance sheet on influencing longer-term interest rates. We show that a lower level of the natural rate of interest reduces monetary policy space through a more frequently binding effective lower bound (ELB), but at the same time expands fiscal space by increasing the sustainable levels of the primary deficit and of the public debt. We further find that systematic balance sheet policies considerably enhance macroeconomic stability in a low rate environment as they help the central bank partly overcoming the ZLB constraint. Our results also suggest that the interactions of fiscal and monetary policy are more pronounced in the presence of the ELB. The effectiveness of balance sheet policies is enhanced in the presence of well-designed countercyclical fiscal policies. At the same time, by protecting against deflation and reducing the refinancing cost of government debt, well-designed balance sheet policies preserve fiscal space and render countercyclical fiscal policy more effective.
Marco Del Negro,
Federal Reserve Bank of New York
Bank for International Settlements
European Central Bank
University of Virginia
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
- E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook