The School of Economics invites you to a seminar by Nigel McClung (Bank of Finland).

Performance of Simple Interest Rate Rules Subject to Fiscal Policy

Abstract

Recent research finds that the U.S. fiscal stance on debt is subject to unobserved and recurring changes that can affect inflation. How should monetary policy be conducted in the presence of recurring fiscal regime change? We study optimal interest rate rules in economies with recurring active fiscal regimes, and describe our results using a generalization of the Leeper (1991) conditions. Many empirically-relevant fiscal policies call for rules that do not depend on the current fiscal regime, notably, interest rate pegs. Still, we find that in some empirically-relevant cases, central banks will lose control of inflation unless the monetary stance tracks fiscal regime changes. These results hold under rational expectations, and in a novel adaptive learning model with unobserved policy regimes.