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Fiscal and Monetary Policy Coordination, Macroeconomic Stability, and Sovereign Risk

Author

Listed:
  • Dennis Bonam

    (VU University Amsterdam, The Netherlands)

  • Jasper Lukkezen

    (Utrecht University, Utrecht, CPB Netherlands Bureau for Economic Policy Analysis, The Hague, The Netherlands)

Abstract

In standard macroeconomic models, debt sustainability and price level determinacy are achieved when fiscal policy avoids explosive debt and monetary policy controls inflation, irrespective of the relative strengths of each policy stance. We examine how these policy requirements for equilibrium stability and determinacy change in the presence of sovereign risk. An increase in sovereign risk reduces lender's willingness to hold government debt and raises consumption and inflation. Therefore, inflation and debt dynamics are determined jointly. To ensure stable macroeconomic conditions, both the fiscal and monetary stance must shift to offset debt sustainability concerns. We find that the adoption of a deficit target helps alleviate such concerns and raises the scope for macroeconomic stability.

Suggested Citation

  • Dennis Bonam & Jasper Lukkezen, 2014. "Fiscal and Monetary Policy Coordination, Macroeconomic Stability, and Sovereign Risk," Tinbergen Institute Discussion Papers 14-006/VI, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20140006
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    References listed on IDEAS

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    Cited by:

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    2. Reicher, Claire A., 2014. "Fiscal targeting rules and macroeconomic stability under distortionary taxation," Kiel Working Papers 1968, Kiel Institute for the World Economy (IfW Kiel).
    3. Sarb, 2020. "OBEN 2001 November 2020," Occasional Bulletin of Economic Notes 11003, South African Reserve Bank.
    4. Guilherme Bandeira, 2018. "Fiscal transfers in a monetary union with sovereign risk," Working Papers 1807, Banco de España.

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    More about this item

    Keywords

    Fiscal and monetary policy coordination; equilibrium determinacy and stability; sovereign risk; policy rules;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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