The dire effects of the lack of monetary and fiscal coordination
© 2018 Elsevier B.V. If the government's willingness to stabilize debt is waning, while the central bank is adamant about keeping inflation low, the economy enters a vicious spiral of higher inflation, monetary tightening, recession, and further debt accumulation. The mere possibility of this conflict represents a drag on the economy. A commitment to inflate away the debt accumulated during a large recession leads to welfare improvements and lower uncertainty by separating long-run fiscal sustainability from the short-run fiscal stimulus. This strategy can be used to avoid the zero lower bound. As a technical contribution, we explain how to build shock-specific policy rules.
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