Tradeoffs, Delegation, and Fiscal-Monetary Coordination in a Developing Economy

Abstract

Strategic interaction between fiscal and monetary authorities and economic agents, can lead to the creation of more populism than is socially optimal. The tradeoffs through which this occurs, important for a populous democracy with a large number of poor, is that between populism and growth. This has not received much analytical attention. We derive this tradeoff from microfoundations (i) show that a Nash equilibrium will occur with a level of populism higher than the optimal; fiscal and monetary interaction will lead to output below feasible levels, (ii) specify the conditions on which the results depend, (iv) discuss stabilisation possibilities, and (v) show that optimal delegation to a pro-growth monetary authority and a conservative fiscal authority would lower populism and inflation, while keeping growth at sustainable levels. Last, the model is used to interpret Indian macroeconomic performance.

Keywords: tradeoffs, dynamic inconsistency, fiscal-monetary co-ordination, delegation

JEL Classification: E63, O11