The central bank or the government–who really dictates the terms of the policy-mix cooperation in economies with an independent monetary policy?

Abstract

The objective of this paper is to consider the cooperative game between the central bank and the government in the case of a non-euro country in the European Union or another country in the world that conducts an independent monetary policy and where statutory deficit restrictions were imposed on its budget. The study takes into account two independent players–the government and the central bank–that make autonomous decisions and are responsible for fiscal and monetary policy, respectively. Our mathematical policy mix model is based on the assumption that there exists some level of coordination between these policies. The article aims to analyse how the level of cooperation influences the behaviour of decision-makers in a specific policy mix model. As a result, the government taking into account the central bank’s goals has no impact on the equilibrium of the budget deficit and interest rates. The conclusion about the central bank’s privileged position emerged as a mathematical consequence of the proposed model. This is confirmed by another case where the government does not consider the central bank’s target in its decisions; then, it does not prevent the monetary authorities from influencing the Nash equilibrium level of either decision variable.