Monetary-Fiscal Coordination : When, Why and How?

The issue of fiscal-monetary coordination has received renewed focus in the wake of the COVID-19 crisis. The paper revisits this theme using a calibrated New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model, that allows for unconventional monetary policy and monetary policy transmission over and above the standard features. We use inflation-output trade-off as a metric to analyze fiscal-monetary interaction. Our analysis reaffirms the conventional notion that monetary policy can independently pursue the objective of inflation stabilization when fiscal policy ensures debt sustainability but needs to be accommodative when fiscal policy turns active (disregards debt stabilization). Additionally, the impulse responses from the model show that monetary policy transmission is impeded in the presence of high debt levels which can be addressed by unconventional tools. Considering key developing country characteristics, we find inflation-output trade-off to be higher in the presence of supply constraints. In the case of a higher share of non-Ricardian households and weaker monetary policy transmission, the inflation-output trade-off becomes regime-dependent