• Monetary and Fiscal Policy Interactions in an Emerging Open Economy: A Non-Ricardian DSGE Approach

Monetary and fiscal policy interactions have attracted new research interest since the 2008 crisis due to a global increase of fiscal debt. This paper constructs a macroeconomic model of joint fiscal and monetary policies for an emerging open economy, incorporating its structural specifics: two monetary instruments -- interest rate to target inflation and foreign exchange interventions to manage exchange rate, two fiscal instruments -- public consumption and public investment, two types of households -- forward-looking optimizers and rule-of-thumb consumers, and foreign debt via collateral constraint. Parameters are calibrated for the case of Hungary. The results show that public investment and public consumption differently affect the exchange rate, foreign debt, and private capital. A collateral constraint changes the transmission mechanism of fiscal, monetary, and foreign demand shocks and makes the model volatile due to its Lagrange multiplier, which enters the uncovered interest rate parity condition and influences the exchange rate.  


Earlier Research:

  • Worked on a macro-econometric model KMOD with Professor David Kemme and analysts at the National Bank of Kazakhstan, 2007-2008
  • Fiscal/Oil Dominance, Inflation, and Policy Coordination [in Kazakh and Russian]. Economic Review of the National Bank of Kazakhstan, 2010, 2, 1-9

Fiscal dominance is related to the fiscal theory of the price level, stating that fiscal deficit causes an increase of prices due to a budget constraint which holds in equilibrium. This paper empirically finds that Kazakhstan, as an oil exporting economy, has fiscal dominance due to an existence of the cointegration relationship between fiscal debt and non-oil primary fiscal balance: 1% increase of debt leads, on average, to about 5.9 bln tenge fall in non-oil primary balance. Second, there is a cointegration relationship between aggregate consumption expenditures and non-oil primary balance: 1% increase of consumption leads, on average, to about 1.82 bln tenge fall in non-oil primary balance. Consumption growth, in turn, Granger causes inflation, suggesting demand-pull inflation in the economy. Third, there is a strong cointegration relationship between non-oil primary balance and oil revenues, which are transfers from the SWF to the government budget: an increase of non-oil primary surplus by 1 bln tenge leads, on average, to about 720.2 mln tenge fall in the oil revenues of government budget. In other words, non-oil fiscal deficit is financed by the discretionary transfers from SWF. The limitation of this study, however, is short time series (2000Q1-2009Q3), as oil revenues of government budget were not separated from total fiscal revenues prior to 2000Q1 in public finance statistics. The policy implications might be to follow a well-defined fiscal policy rule in order to avoid excessive expansion and fiscal unsustainability, promote an effective coordination between monetary and fiscal authorities to achieve price stability, and a transparent use of SWF for productive public investment projects.