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325_Lecture21_April18

325_Lecture21_April18 - FISCAL AND MONETARY INTERACTIONS...

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1 F ISCAL AND M ONETARY I NTERACTIONS A PRIL 18, 2011 April 18, 2011 2 M ONETARY P OLICY AND F ISCAL P OLICY Introduction Chapter 7: studied fiscal policy in isolation from monetary policy Illustrated some core issues of fiscal policy (i.e., lifetime budget constraint of government, Ricardian Equivalence) Chapter 14: studied monetary policy in isolation from fiscal policy Illustrated some core issues of monetary policy (i.e., neutrality debate, long-run monetarist link between money growth and inflation) Monetary policy and fiscal policy don’t occur in vacuums isolated from each other Both occur simultaneously The conduct of fiscal policy can place restrictions on what monetary policy can do, and vice-versa Chapter 15: Interactions between fiscal and monetary policy Focus on dynamic unfolding of events Main idea: budget constraints/balance sheets of one policy authority affect the other policy authority
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2 April 18, 2011 3 M ONETARY P OLICY AND F ISCAL P OLICY Model Structure Representative consumer will be “in the background,” not the focus, of analysis in Chapter 15 No explicit utility maximization problems, etc. But we know where optimal choices of c t and M t / P t etc. come from… Focus will just be on government actions An infinite-period framework Two distinct “sides” of the government Fiscal authority – i.e., Congress/Treasury Controls government spending g t Collects taxes T t (will assume only lump-sum taxes throughout) Issues (sells) new bonds (for various financing needs) Monetary authority (aka central bank) – i.e., Fed Controls money supply of economy… …by engaging in open-market operations April 18, 2011 4 M ONETARY P OLICY AND F ISCAL P OLICY Model Structure Representative consumer will be “in the background,” not the focus, of analysis in Chapter 15 No explicit utility maximization problems, etc. But we know where optimal choices of c t and M t / P t etc. come from… Focus will just be on government actions An infinite-period framework Two distinct “sides” of the government Fiscal authority – i.e., Congress/Treasury Controls government spending g t Collects taxes T t (will assume only lump-sum taxes throughout) Issues (sells) new bonds (for various financing needs) Receives “profits” from central bank (because it legally charters C.B.) Monetary authority (aka central bank) – i.e., Fed Controls money supply of economy… …by engaging in open-market operations Turns over any “profits” it earns to fiscal authority Balance sheet linkage between fiscal and monetary policy
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3 April 18, 2011 5 F ISCAL A UTHORITY Model Structure Fiscal authority budget constraint in period t B T t : the TOTAL amount of (one-period) bonds (each with FV = 1) Congress sells in period t , each of which has price P b t B T t -1 : the TOTAL amount of (one-period) bonds (each with FV = 1) that Congress must repay in period t RCB t : r eceipts (profits) turned over from the c entral b ank to the fiscal authority in period t 1 b t t t t t t T T t B B RC g T B P P ± ² ² ² bonds P b Total S – what Congress actually sets
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