The onset of the pandemic saw a high degree of coordination between our monetary and fiscal authorities. The Bank of Canada lowered its overnight rate to its effective lower bound and engaged in quantitative easing, governments pumped in stimulus and support programs, and the Office of the Superintendent of Financial Institutions (OSFI) lowered its domestic stability buffer to add extra lending space for Canada’s largest financial institutions. Despite a short and sharp drop in economic growth in the first half of 2020, these coordinated policies were broadly a success.However, since April 2021, inflation in Canada has far exceeded the top end of the Bank of Canada’s inflation target range (1-3 percent). The Bank, which was slow off mark, is now sharply tightening monetary policy, and the federal government has shrunk the deficit through higher tax revenue from higher inflation. But it has also added new spending to the mix.In this paper, our goal is to understand how these fiscal and monetary authority interactions – be they in coordination or in conflict – at different points in the cycle (e.g., recession/recovery), affect macroeconomic expectations, and, as a result, macroeconomic outcomes. While our findings are relevant in Canada’s current context, critically, they apply more generally as well.Economic theory suggests that under coordination, because rational households and businesses anticipate that the monetary and fiscal authorities will work together, the recession is less severe, and the recovery is stronger, happening at a quicker pace. Under conflict, theory suggests that governments continue to accumulate debt, which fuels inflation, while the central bank raises rates to lower inflation, causing the servicing cost of debt to rise. This debt burden will dampen the economic recovery and has the potential to cause a double-dip recession.To test this economic model of policy conflict and coordination, we designed a lab experiment where participants, consisting of undergraduate students from diverse disciplines, interacted in a simulation economy and were asked to make predictions about future macroeconomic outcomes.The primary policy conclusion from our experimental findings is that people do not exhibit sufficiently forward looking behaviour for expectations of future policy conflict to matter. People respond to the recent state of the economy and not on how fiscal and monetary authorities will react at some future moment in time. In other words, participants use some form of historical information to formulate their expectations, with the large majority of them using historical trends to forecast inflation and the output gap (between actual and potential output).These findings have implications for both governments and the Bank of Canada. Ideally, with the Bank firmly in a tightening cycle to get inflation under control, governments would contribute to this fight by not adding new spending. This would help achieve those necessary results. However, should this not be the path fiscal authorities choose, while conflict might make things harder, our results suggest that the optimal path for the Bank of Canada is to continue its tightening cycle to get inflation back under control in order to re-anchor inflation expectations
