Macroeconomic Regimes as Institutional Architectures

Endogenous Fiscal Credibility and State-Dependent Monetary Policy

Abstract

This paper studies how beliefs about fiscal backing shape monetary–fiscal regimes and how fiscal choices influence those beliefs. Credibility is updated from observed compliance using discounted Beta learning. Conditional on credibility, a threshold separates fiscal from monetary dominance, governs the response of the price level to interest-rate-rule disturbances, and changes the inflation-variance-minimizing monetary response. A debt-dependent fiscal limit yields a credibility frontier under a frozen effective-backing approximation; this approximation matches the local fiscal response at steady-state debt but does not establish a fully endogenous-feasibility equilibrium. The paper's distinctive contribution is an optimizing fiscal authority. In a deterministic benchmark, optimal policy reaches the monetary-dominance threshold from outside a credibility trap, while sustained dominance requires an additional maintenance condition. That condition holds in the computed rebuilding cases, not for all parameters. Relative to an independent exogenous-backing benchmark, fiscal choices make regime transitions depend on political incentives and inherited credibility. Numerical results with debt and private political-cost shocks show persistent low credibility and preventive fiscal backing at higher obligations. Argentina serves as an illustration rather than an empirical test.