Strategic Interaction between Fiscal and Monetary Policies in an Export-Oriented Economy

1. Strategic Interaction between Fiscal and Monetary Policies in an Export-Oriented Economy Sergey Merzlyakov Junior Research Fellow of the Laboratory for Macroeconomic Analysis National Research University Higher School of Economics, Moscow

2. Contents • Motivation • Literature on Fiscal and Monetary Policy Interaction • Model • Strategic Interaction • Conclusion

3. Motivation • Why strategic interaction? • Complementary policy instruments • Joint constraint • Peculiarity of macroeconomic development in an export-oriented economy • Optimal macroeconomic policy design • Central bank independence: do we really need it?

4. Literature review • Fiscal and monetary policy interaction: Christ (1979), Sargent and Wallace (1981), Blinder (1982) • Strategic complementarity instruments: Andersen and Schneider (1986), Dixit and Lambertini (2003) • New political economy in macroeconomics setup: Drazen (2000), Persson and Tabellini (2000)

5. Two-period modelKey points • Fiscal policy • Discretionary policy (lump-sum taxes, government expenditure) • Automatic stabilizers (taxes that depend on export and output) • Stabilization fund (as the sterilization mechanism of excessive money) • Monetary policy • The only transmission monetary channel is foreign currency operations • Exchange rate target • Export and import depend on exchange rate • By changing the international reserves, • the central bank changes the supply of money Endogenous variables: Predetermined variables: all variables in period 0 Policy variables:

6. Model • Aggregate Demand • Phillips Curve • Government Budget Constraint • Balance of Payment • Foreign Exchange Market Operations • Money in Circulation • Real Exchange Rate • Social Loss Function

7. Forms of strategic interaction • Dependent central bank: fiscal and monetary policy coordination • Independent central bank: • Stackelberg interaction with the government leadership • Cournot interaction (central bank and government do not take each others’ actions into account when choosing their policies) The government loss: The central bank loss:

8. What is the optimal bargaining power of the government relative to the central bank? Coordination: the loss function

9. Coordination is effective only if the bargaining power of the central bank is relatively large 1,2 0,00020 0,986 0,00018 1,0 0,00016 0,00014 0,8 0,00012 0,6 0,00010 0,00008 0,4 0,00006 0,00004 0,099 0,2 0,010 0,00002 0,005045 0,000118 0,0 0,00000 0,01 0,5 1 10 100 Bargaining power Government and central bank loss Social loss Coordination: the bargaining power

10. Agents’ losses are sensitive to fiscal policy Central bank independence: agents’ losses

11. Conclusion • In an export-oriented economy the independence of the central bank does not play a significant role • Coordination is preferable if the bargaining power of the central bank is relatively large • Interaction with the government leadership is preferable if the output is government priority • Next: to compare different monetary policy regimes (exchange rate target vs. growth rate of money target), to analyze other forms of strategic interaction (the central bank leadership)

12. Thank you for your attention!