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Optimal Fiscal Stabilization Policy With Credible Central Bank Independence

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  • L. Lambertini
  • R. Rovelli

Abstract

We study a model where monetary and fiscal policy share the task of stabilizing output and inflation, and the central bank has been assigned a mandate for the latter. The optimal fiscal policy does not imply assigning to the government a (symmetric) mandate to stabilize output. Instead, the optimal response to the aggregate demand and supply shocks may be characterized as equivalent to an automatic stabilizer. An alternative but equivalent characterization of fiscal policy is that the government should maximize a model social welfare function, respectively over (under) weighting the objective of price stability versus output stability when the relative size of aggregate demand vs supply shocks is large (small). This over (under) weighting of the two objectives is only apparent , as it is in fact the logical consequence of having defined the mandate of the central bank in terms of one objective only.

Suggested Citation

  • L. Lambertini & R. Rovelli, 2002. "Optimal Fiscal Stabilization Policy With Credible Central Bank Independence," Working Papers 460, Dipartimento Scienze Economiche, Universita' di Bologna.
    • Handle: RePEc:bol:bodewp:460
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    1. L. Lambertini & R. Rovelli, 2003. "Monetary and fiscal policy coordination and macroeconomic stabilization. A theoretical analysis," Working Papers 464, Dipartimento Scienze Economiche, Universita' di Bologna.

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