Coordinating Monetary and Fiscal Policies in an Open Economy
Coordinating Monetary and Fiscal Policies in an Open Economy

Summary/Abstract: This paper looks at the possible coordination problems that might result when monetary and fiscal policies are operated by separate authorities. In an open economy the feedback from movements in the exchange rate to the rate of consumer price inflation means fiscal policy can have a non-neutral effect on output even if monetary policy acts to keep inflation at target. This might encourage governments to run an overly expansive fiscal policy at the expense of weakness in the tradable sector. Preventing this scenario might require the monetary authority to target a measure of domestically-generated inflation or have a separate target for the exchange rate. Alternatively the government could delegate the assessment of policy against its fiscal rules to an independent fiscal council.

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