Examining the Effects of Passive Monetary Policy in an Environment with Active Fiscal Policy

Document Type : RESEARCH PAPER

Authors

1 PhD in Economics, Department of Economics, Faculty of Economics and Administrative Sciences, Lorestan University, Khorramabad, Iran

2 Assistant Professor of Economics, Department of Economics, Faculty of Economics and Administrative Sciences, Lorestan University, Khorramabad, Iran

3 Associate Professor of Economics, Department of Economics, Faculty of Economics and Administrative Sciences, Lorestan University, Khorramabad, Iran

4 Professor of Economics, Department of Economics, Faculty of Economics, Razi University, Kermanshah, Iran

Abstract

Understanding the interaction between monetary and fiscal policies and their impact on macroeconomic variables is crucial for sustainable economic policies. Uncoordinated policies can amplify economic fluctuations, increase uncertainty, and hinder long-term growth. This study examines the consequences of different active and passive monetary and fiscal policy combinations on key macroeconomic variables, including consumption, production, and investment.
A dynamic stochastic general equilibrium (DSGE) model is developed to achieve this, incorporating households categorized into Ricardian and non-Ricardian groups. Fiscal policy is introduced through tax rules, and various policy scenarios are analyzed. The model's structural parameters are estimated using the Bayesian method and quarterly data from the Iranian economy from 2004 to 2023.
The findings highlight the pivotal role of monetary and fiscal policy interaction in shaping macroeconomic stability, especially in economies facing structural challenges and policy constraints. Economic instability increases when fiscal policy is active while monetary policy remains passive. Passive monetary policy limits the central bank’s ability to counteract inflationary pressures from expansionary fiscal policies. Increased government spending and fiscal deficits drive inflation, leading to greater volatility. This combination undermines the central bank’s capacity to stabilize inflation and output, creating an unsustainable economic environment.

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