Monetary and Fiscal Policy Interaction: What is the Role of the Transaction Cost of the Tax System in Stabilisation Policies?

Panagiotis Chronis () and Aspassia Strantzalou
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Panagiotis Chronis: Bank of Greece
Aspassia Strantzalou: Ministry of Employment and Social Protection, Greece

No 71, Working Papers from Bank of Greece

Abstract: In the theory of monetary and fiscal policy interaction, the assumption of Ricardian households isolates the determinants of fiscal policy instrument from the price stabilization policies carried out by the central bank. One of the main implications of the above mentioned Ricardian assumption is that the fiscal policy does not have any distortionary effect for the economy, i.e. it does not affect the behaviour of the households, supporting that way the fiscal policy’s neutrality. The argument for this view comes if one assumes that fiscal policy has a distortionary effect on the behaviour of the agents. We relax the above non distortionary assumption by assuming that the imposition of the taxes is consistent with a transaction cost of the tax system that underlies the state - tax payer interaction. In this way we develop a channel through which the stability of prices carried out by the independent central bank is, within optimality, also a function of the fiscal policy determinants (the transaction cost, the tax rates and the debt level). The analysis is carried out in a framework of a monetary union, with two different countries. Within this framework, the effectiveness of a numerical fiscal rule is also examined.

Keywords: Monetary and fiscal policy interactions; Transaction cost of the tax system; Probability of re-election; Stability and growth pact (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 E63 H60 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2008-05
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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