Fiscal Policy, Institutional Quality and Central Bank Transparency

Abstract

This paper examines monetary and fiscal interactions in a framework where the government as Stackelberg leader worries about political costs of corruption and central bank opacity acts as a fiscal disciplinary device. Opacity could reduce (increase) inflation expectations, inflation (the output gap) and the responses of these variables to supply shocks, and would improve social welfare. Under the least favourable assumptions on the effect of corruption, i.e. 'sanding-the-wheels' or weak 'greasing-the-wheels' effect, opacity has a fiscal disciplining effect that could be reinforced by grand corruption. Intransparency increases corruption only if the 'greasing-the-wheels' effect is relatively large.