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Monetary/Fiscal Policy Mix and Agent's Beliefs

Author

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  • Francesco Bianchi

    (Duke University)

  • Cosmin Ilut

    (Duke University)

Abstract

We estimate a model for the US economy with monetary/fiscal policy mix changes. Monetary policy accommodated fiscal policy through the '60s-'70s leading to high inflation. Monetary policy changed with Volcker, but inflation dropped only when fiscal policy and agents' beliefs about fiscal backing switched; successful disinflations require fiscal backing. If the monetary authority had always led or if agents had been confident about this switch, the Great Inflation would not have occurred. The policy change explains why, in the '80s, inflation dropped, debt-to-GDP reversed, output fell, and inflation persistence and volatility declined. Absent this change, inflation would have remained high for fifteen years. (Copyright: Elsevier)

Suggested Citation

  • Francesco Bianchi & Cosmin Ilut, 2017. "Monetary/Fiscal Policy Mix and Agent's Beliefs," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 113-139, October.
    • Handle: RePEc:red:issued:16-166
    DOI: 10.1016/j.red.2017.02.011
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    More about this item

    Keywords

    Fiscal policy; monetary policy; inflation; Bayesian methods; Markov-switching DSGE;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • 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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