Monetary and Fiscal Policy in a DSGE Model of India

Working Papers from National Institute of Public Finance and Policy

Abstract: We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explict target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies.The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions. It is calibrated using India and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules. A comparison with a fixed exchange rate regime is ade. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy. These policy prescriptions contrast with the monetary-fiscal policy stance of the Indian authorities.

Keywords: Monetary policy; Emerging economies; Fiscal and monetary rules; Financial accelerator; Liability dollarization (search for similar items in EconPapers)
JEL-codes: E37 E52 E58 (search for similar items in EconPapers)
Pages: 47
Date: 2011-11
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Note: Working Paper 96, 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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