Harmonizing fiscal and monetary: optimal monetary policy under expenditure fiscal rules
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2024-05-10
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Teles, Vladimir Kuhl
Ribeiro, Marcel Bertini
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This research employs a standard TANK model augmented with a procyclical fiscal rule to address two issues. First, the impact of expenditure-based fiscal rules with varying degrees of procyclicality on the dynamics of macroeconomic variables. Second, the impact of the degree of procyclicality in the optimal simple monetary policy. The fiscal framework is inspired by Brazil’s current and former fiscal rules. The model suggests that the response to inflation of the optimal simple monetary rule has a U-shaped relation with the procyclicality of the fiscal policy. At extreme values of procyclicality, inflation variance is high and there is no monetary policy trade-off. At the lower end, this is driven by the pronounced demand effect exerted by hand-to-mouth agents. Conversely, when the procyclicality exceeds a certain threshold, the fiscal response dictated by the expenditure rule heightens inflation variance. Only within a range of moderate procyclicality inflation variance diminish sufficiently to permit the emergence of a monetary policy trade-off.