Essays on Monetary Policy Interactions with Fiscal Policy and Financial Markets

Abstract

This dissertation aims at contributing to the literature investigating the positive and normative framework for monetary policy. It provides an assessment of macroeconomic (i.e. monetary and to some extent also fiscal) policies by focusing on two rather distinct dynamic general equilibrium environments which help shed light on a number of critical aspects regarding the dynamic conduct of monetary policy. The main questions asked are of both theoretical and empirical nature and concern the way monetary policy interacts with fiscal policy and financial markets: How does nominal government debt shape the incentives faced by monetary policy makers? What is the nature of the monetary time consistency problem when there is interaction with sequential fiscal policy makers? Can the dynamic interplay of monetary and fiscal policies explain the evolution of government debt and inflation? How can we rationalize the negative correlation between inflation and aggregate productivity observed at business cycle frequency? What role do nominal interest rates and the provision of liquidity play in this context?<br /> A unifying starting point for the set of models laid out in this thesis are specifications proposing that monetary policy does not operate in isolation, but interacts with other agents or institutions. The first two chapters concentrate on the strategic aspects underlying the interaction of monetary and fiscal policies in an economy characterized by positive amounts of government debt in nominal denomination. Specifically, in order to reexamine the time consistency properties of optimal monetary policy, chapter one poses a dynamic optimal taxation problem where not only monetary, but also fiscal policies are sequentially implemented. Starting from this scenario, the next chapter provides a positive theory of dynamic monetary-fiscal interactions and a reflection on the institution of monetary conservatism, whose role is shown to be inherently determined via its implications for the interaction with fiscal policy. The third chapter takes a different and more empirically oriented route: It elaborates on an incomplete markets environment in order to demonstrate how monetary policy systematically affects an economy's aggregate productivity. Key for this conclusion is to acknowledge that nominal fluctuations induced by monetary policy on the one hand and financial markets' capacity to intermediate scarce liquidity on the other hand interact in a way that has an important influence on corporate activity, thus affecting aggregate productivity.