On the stressful interaction of monetary and fiscal targets

Author's Department

Economics Department

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https://doi.org/10.1016/j.iref.2025.104708

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Sebastian Ille Dat Thanh Nguyen Edgar J. Sanchez Carrera

Document Type

Research Article

Publication Title

International Review of Economics and Finance

Publication Date

12-1-2025

doi

10.1016/j.iref.2025.104708

Abstract

In this paper, we study an asymmetric strategic and dynamic interaction between two policymakers, the Central Bank and the Government, during periods of fiscal stress induced by the imperative of delivering the targeted debt levels. The Central Bank determines the monetary policy and the government controls fiscal policy. Strategies are driven by inflation, public debt, and government transfer payments to households. We show that the combination of monetary expansion and fiscal contraction cannot be a Nash equilibrium and is therefore not evolutionarily stable. Yet, regimes in which both players run either expansionary or contractionary policies can be maintained both as global and local attractors. In addition, the interaction is also able to sustain an asymmetric global equilibrium in which the Central Bank uses a contractionary policy while the government opts for an expansionary fiscal policy. We provide the conditions for each of these scenarios and show that these are in line with empirical results.

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