The Big Picture of Monetary-Fiscal Interactions

The paper offers a schematic game theoretic approach to thinking about medium-term strategic interactions between monetary and fiscal policy. We show that under some circumstances fiscal excesses may spill over to monetary policy, but a legislated commitment to a numerical inflation target can sometimes prevent this through providing the central bank with ammunition to counter-act excessive fiscal actions. As such, a more explicit monetary commitment may have a 'disciplining effect' on fiscal policy, and improve fiscal outcomes as well as monetary outcomes. We present some empirical evidence for this finding.