The article examines how government spending is determined in a closed
economy where the nominal wage is pre-set through contracts and the wage setters
have perfect foresight regarding subsequent policy decisions. The monetary
regime affects government spending because: (i) with a pre-set nominal wage, a
given change in government spending has different effects on employment and
inflation under different monetary regimes, and (ii) the authorities’ inclination
to expand government spending is affected by the inflation rate which depends
on the monetary regime. If the costs related to inflation are high, a comparison
between monetary regimes suggests that welfare is highest under nominal
income targeting where the nominal income target is determined to bring about
price stability.
Keywords: Monetary regimes; fiscal policy; monetary non-neutrality.
JEL classicification: E42, E61, E62.
