2017 - Fiscal and monetary policy in a changing economic and political environment

On 9 and 10 October DNB organized its twentieth Annual Research Conference. This year the conference theme was “Fiscal and Monetary Policy in a Changing Economic and Political Environment”. The conference featured keynote speeches by John Cochrane (Stanford University) and Nobel Prize winner Chris Sims (Princeton). Eight research papers were presented and a policy panel discussed the conference theme. 

 
In his keynote speech John Cochrane questioned the validity of mainstream economic models because they fail to explain the current low and stable inflation. Whereas the Old Keynesian model predicts a deflationary spiral, the New Keynesian model predicts multiple equilibria and therefore very volatile inflation. The Monetarist models, in contrast, predict hyperinflation due to the large expansion of central bank balance sheets. None of this was observed. John shows that the Fiscal Theory of the Price Level is able to explain the recent history of low and stable inflation. 
 
Chris Sims reflected in his keynote speech on the experiences of the European Monetary Union. In his view a key missing aspect is the orderly resolution of government defaults. Consequently, bankruptcies of a single country can threaten the existence of the entire monetary union. Reform of the Eurozone is complicated by the fact that “we are discussing insurance after the house has burned down”. According to Sims, ex-ante risk sharing by means of, e.g., ESBies and fiscal backing of the ECB are important instruments that can facilitate an orderly resolution of sovereigns. 
 
The presented papers all studied different aspects of fiscal and monetary policy interactions in the theoretical models we use. For example, Leopold Von Thadden (ECB) and Dennis Bonam (DNB) studied the stability of a monetary union conditional on switching between active and passive fiscal and monetary policy. Salvatore Nistico (Sapienza University Rome) analyzes theoretically when unconventional open-market operations by central banks affect output and inflation. Open-market operation are not neutral when treasury's support is absent or if the treasury is unable or unwilling to tax households to cover central bank's losses. 
 
Dominik Thaler (Bank of Spain) shows that his model can explain the movement from a corridor system to a floor system by the size of the central bank balance sheet. Other topics that were presented dealt with the stability of equilibria when either the government or central bank conducts regime switching policies (Guido Ascari, Oxford University). The importance of agents’ beliefs for sovereign debt limits and the effectiveness of monetary policy (Niccolo Battistini, ECB). 
 
Florin Bilbiie (Paris School of Economics) and Markus Hagedorn (Oslo University) questioned some basic assumption in the mainstream models. Florin shows how results change when the consumption of hand-to-mouth consumers is not modelled as a fraction of total income in the economy as is generally assumed, but as a fraction of their own income. Finally, Markus offers a new perspective on price level determination by highlighting the role of incomplete markets. 
 
More information can be found in the program.