Events at CERGE-EI

Fernando M. Martin, Ph.D.

Federal Reserve Bank of St. Louis, Missouri, USA

Author: Fernando M. Martin

Abstract: Recent events have renewed the debate on the desirability of imposing institutional constraints on government policy. This paper investigates how policy constraints discipline the behavior of discretionary governments in dynamic stochastic monetary economies and evaluates the welfare properties of such restrictions. Across a variety of possible shocks, the best policy overall is to target the nominal interest rate during normal times and letting it behave with discretion during adverse times. In contrast, an inflation target is ineffective or detrimental. It is never optimal to suspend constraints on fiscal policy during adverse times and the best fiscal regime is to impose a small primary surplus.

Full Text:  “The Value of Constraints on Discretionary Government Policy”