Infrequent Fiscal Stabilization

Abstract

This paper studies discretionary non-cooperative monetary and fiscal policy stabilization in a New Keynesian model, where the fiscal policymaker uses a distortionary taxe as the policy instrument and operates with long periods between optimal time-consistent adjustments of the instrument. We demonstrate that longer fiscal cycles result in stronger complementarities between the optimal actions of the monetary and fiscal policymakers. When the fiscal cycle is not very long, the complementarities lead to expectation traps. However, with a sufficiently long fiscal cycle -one year in our model -no learnable time-consistent equilibrium exists. Constraining the fiscal policymaker in its actions may help to avoide these adverse effects.