ABSTRACT
The interaction between monetary and fiscal policy is at the heart of macroeconomics, but traditional analysis often ignores the institutional aspects. In recent years, a developing literature has concentrated on issues such as the influence of central bank independence on the conduct of monetary policy, and as a part of this, the extent to which the central bank accommodates fiscal policy. Much less has been done, however, to investigate the reverse interaction: the extent to which central bank independence influences the formation of fiscal policy. This chapter concentrates primarily on that latter channel of influence. Pooled cross-section data for 12 industrialized countries over the 1961–83 period are used to estimate a three-equation model, with monetary policy, fiscal policy and inflation all treated endogenously. The results provide support for the hypothesis that government budget deficits and inflation performance are indeed both affected by the independence of the central bank.
