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"Monetary Instrument Problem Revisited: The Role of Fiscal Policy"

Soyoung Kim


First Author :

Soyoung Kim
University of Illinois at Urbana-Champaign
1206 S. Sixth Street, M/C 706
Champaign, IL 61820

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.
JEL Classification : E63 , E52 , E31
Keywords :
fiscal determination of the price level, fiscal policy, monetary instrument problem, nominal government debt, variance of inflation
Manuscript Received : 2001
Manuscript Published : 2001
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