Economic Papers

  1. Publications
  2. Other Publications
  3. Economic Papers

Macroeconomic Policy Mix and Social Welfare(EP Vol.10 No.2)

연구조정실 (02-759-5407) 2008.01.03 10592

Macroeconomic Policy Mix and Social Welfare

Author: Hyun-Jeong Kim(Institute for Monetary and Economic Researh, Bank of Korea)

            Seong-Hun Yun(Institute for Monetary and Economic Researh, Bank of Korea)


The paper examines, theoretically and empirically, the social welfare
implications of the interaction (or game) between monetary and fiscal
authorities in a small open economy under an inflation targeting regime.
Theoretically, it considers four types of policy game (Nash, monetary
leadership, fiscal leadership, and cooperation) and shows that, when there is
a cost-push shock, it is possibile for fiscal and monetary policies to
contradict each other in a Nash game and two leadership games, magnifying
the volatility of macroeconomic variables and thereby having a negative
effect on social welfare. Comparing expected social welfare losses, it shows
that when the two authorities optimize a common objective function
(cooperation) social welfare loss can be minimized due to harmonized
policies even under a cost-push shock. Nash and fiscal leadership games
have a similar magnitude of social welfare loss, which is bigger than that
under policy cooperation, but much smaller than that under a monetary
leadership game. This implies that it is socially more desirable that the fiscal
authority decides its own policy in consideration of the reaction of the
monetary authority while the latter’s decision making is rule-based (fiscal
leadership) rather than the other way round (monetary leadership).
According to the result of impulse response analysis using Korean macro
data after the financial crisis, fiscal and monetary policies have a
complementary relationship when a demand shock occurs whereas they have
an opposing relationship in the early stage when supply and exchange rate
shocks take place, requiring a longer period for equilibrium recovery.
Consequently, it seems that the macroeconomic policy mix in Korea does not
have the property of cooperation. These results imply that fiscal and
monetary authorities should cooperate more closely together to enhance
social welfare and that fiscal policy should respond more actively to the
business cycle than in the past.

Go to Top