Quadrilemma Not Trilemma: Fiscal Policy Matters
CAEPR Working Paper #2016-003
30 Pages Posted: 27 Aug 2016
Date Written: August 26, 2016
This paper examines the interactions between fiscal policy and the open economy macroeconomic policy trilemma in a small open economy dynamic stochastic general equilibrium model. I show that the trilemma policy regime choices require fiscal accommodation. Otherwise, when future budget surpluses fail to stabilize government liabilities, fiscal imbalance generates exchange rate depreciation, regardless of monetary and capital account policy regimes. In this active fiscal policy regime, fiscal and monetary policy interact to determine the magnitude of exchange rate depreciation, while monetary policy and capital controls manage the timing of the depreciation.
Keywords: Trilemma, Fiscal Policy, Capital Account Policy, Exchange Rate Stability, Monetary Policy
JEL Classification: E62, F33, F38, F41
Suggested Citation: Suggested Citation