Quadrilemma Not Trilemma: Fiscal Policy Matters

• DOI: 10.2139/ssrn.2830509
• Publication Date: 2016-08-31T14:16:20Z
• Authors: Hao Jin
• Keywords: 0502 economics and business; 05 social sciences

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.