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Is monetary and fiscal policy conflict that dire?

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  • Kronick, Jeremy
  • Petersen, Luba

Abstract

Theory predicts that inflation can become unstable when policymakers are in conflict about their post-recession recovery strategies, with the fiscal authority actively borrowing and spending to stimulate economic growth while the monetary authority raises interest rates to tame inflation. Such policy conflict can generate a debt-inflation spiral when agents are forward-looking. We show that the dire effects of policy conflict are less concerning when agents form backward-looking expectations. We then test this prediction in a learning-to-forecast experiment. Our results suggest that policy conflict does not necessarily lead to worse economic outcomes. This finding is driven by the fact that agents rely mostly on recent macroeconomic trends to formulate their expectations and do not meaningfully factor the government debt level or future regime shifts into their expectations.

Suggested Citation

  • Kronick, Jeremy & Petersen, Luba, 2025. "Is monetary and fiscal policy conflict that dire?," Journal of Economic Dynamics and Control, Elsevier, vol. 172(C).
    • Handle: RePEc:eee:dyncon:v:172:y:2025:i:c:s016518892400174x
    DOI: 10.1016/j.jedc.2024.104982
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    More about this item

    Keywords

    Expectations; Monetary policy; Fiscal policy; Policy coordination; Laboratory experiment; Experimental macroeconomics;
    All these keywords.

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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