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The Choice of Monetary Regime - Fiscal Implications

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The article examines how government spending is determined in a closedeconomy where the nominal wage is pre-set through contracts and the wage settershave perfect foresight regarding subsequent policy decisions. The monetaryregime affects government spending because: (i) with a pre-set nominal wage, agiven change in government spending has different effects on employment andinflation under different monetary regimes, and (ii) the authorities’ inclinationto expand government spending is affected by the inflation rate which dependson the monetary regime. If the costs related to inflation are high, a comparisonbetween monetary regimes suggests that welfare is highest under nominalincome targeting where the nominal income target is determined to bring aboutprice stability.Keywords: Monetary regimes; fiscal policy; monetary non-neutrality.JEL classicification: E42, E61, E62.

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Finn Østrup

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