850120 7 / 11 11 / 5 / 2020 too close for comfort? the relationship between monetary and fiscal policy | deutsche bundesbank here, the concept of makeup strategies comes into play. speciﬁcally, under average inﬂation targeting ( ait ), monetary policy responds to deviations of the average inﬂation rate from its target, with the average calculated over a certain window that extends into the past. that means, if the rate of inﬂation has been running below the target, this deviation has to be offset later by rates above the target. inﬂation expectations would accordingly rise over the short term, and ( ceteris paribus ) the real interest rate would fall. thus, makeup strategies could provide some stabilisation gains, especially when policy rates are close to the effective lower bound. the ait concept appears to offer a tailor - made solution for the current situation. but a monetary policy strategy should be designed for the longer term and ﬁt a variety of economic situations. and, in this regard, ait raises some questions. if inﬂation had at some time been moving above the target for a number of years, the central bank would have to push inﬂation not only down to the target but even notably lower, into a range that the central bank currently regards as dangerous. thus, central banks could forgo that and handle ait asymmetrically. this shows that a past - dependent monetary policy can encounter time inconsistency problems. there might be situations in which there are strong incentives to depart from the strategy. and that would come with a price tag : the strategy ’ s credibility could suffer. added to that, the effectiveness of a makeup strategy hinges on the extent to which people understand it and form their expectations accordingly. [ 21 ] that is asking a lot of market participants, but even more of households and ﬁrms. studies suggest that central banks have had limited success in managing households ’ and ﬁrms ’ expectations to date. [ 22 ] but these inﬂation expectations matter when it comes to pricing on the goods markets : when households make decisions about their purchases, when companies set the prices of their products or when employers and trade unions negotiate wages. as you can see, there are various open points that we have to discuss in depth in our review. for me, it is important that we have a strategy which doesn ’ t just produce good results in economic models but also works in

economics have made impressive progress over the past few decades – but unfortunately more in parallel than in cooperation with each other. it is only recently that research has switched to focusing more strongly on the interactions between the financial sector and the real economy. talking of progress : the ongoing refinement of statistical - econometric methods and their application in economic research have brought to light significant insights. nevertheless, the crisis has aroused some doubts about the triumphal progress of mathematics in the economic sciences. by contrast, economic historians, who were already thought to be in something of a backwater, are now attracting more attention again. having said that, modern economic historians do indeed also make use of methods of empirical economic research, but look back further into the past than is customary. the book “ this time is different ” by carmen m. reinhart and kenneth s. rogoff is not only one of the best - selling books in the crisis literature ; it has also been a reminder that financial and debt crises have been a constantly recurring phenomenon for centuries. one classic of financial history, “ manias, panics and crashes ” by charles p. kindleberger, is rediscovered in every crisis. in it, kindleberger shows in numerous episodes that earlier centuries repeatedly witnessed speculative bubbles and exaggerations on asset markets : tulip mania in 17th century holland, for example, or the south sea bubble and the mississippi bubble in the 18th century, which perhaps triggered the first international financial crisis. kindleberger cites one banker who invested in shares of the south sea company in 1720 as saying that, if the rest of the world takes leave of its senses, one must join in to a certain extent. that is very reminiscent of chuck prince, the former ceo of citigroup, who, in 2007, came up with the legendary remark that “ as long as the music is playing, you ’ ve got to get up and dance ”. bis central bankers ’ speeches there ’ s nothing new under the sun, one might say in summary. 3. do economists have to rethink? 3. 1 financial market regulation yet, the crisis has also called into question a number of economic policy paradigms. first and foremost, the financial and debt crisis has revealed design flaws in the financial and monetary systems. the liberalisation of the financial markets is now viewed much more critically than before the crisis. confidence in the efficiency of the markets has been severely shaken by the financial crisis and many financial market products have failed to