IMF Working Papers Volume 2008 Issue 164: Strategic Interactions between an Independent Central Bank and a Myopic Government with Government Debt (2008)

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Strategic Interactions between an Independent Central Bank and a Myopic Government with Government Debt

Author:

Sven Jari Stehn

Sven Jari Stehnnull

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Mr. David A Vines

Mr. David A Vines
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Series:: IMF Working Papers

Volume/Issue:: Volume 2008: Issue 164

Language:: English

Publication Date:: 01 Jul 2008

DOI:: https://doi.org/10.5089/9781451870220.001

ISBN:: 9781451870220

ISSN:: 1018-5941

Pages:: 38

Keywords:: WP; central bank; government spending; myopic government

Legal-disclaimer:: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Series:: IMF Working Papers

Volume/Issue:: Volume 2008: Issue 164

Language:: English

Publication Date:: 01 Jul 2008

DOI:: https://doi.org/10.5089/9781451870220.001

ISBN:: 9781451870220

ISSN:: 1018-5941

Pages:: 38

Keywords:: WP; central bank; government spending; myopic government

Legal-disclaimer:: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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We analyse optimal discretionary games between a benevolent central bank and a myopic government in a New Keynesian model. First, when lump-sum taxes are available and public debt is absent, we show that a Nash game results in too much government spending and excessively high interest rates, while fiscal leadership reinstates the cooperative outcome under discretion. Second, we show that this familiar result breaks down when lump-sum taxes are unavailable. With government debt, the Nash equilibrium still entails too much public spending but leads to lower interest rates than the cooperative policy, because debt has to be adjusted back to its pre-shock level to ensure time consistency. A setup of fiscal leadership does not avoid this socially costly outcome. Imposing a debt penalty onto the myopic government under either Nash or fiscal leadership raises welfare substantially, while appointing a conservative central bank is less effective.

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IMF Working Papers

ISSN:: 1018-5941

Publisher:: International Monetary Fund

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