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Fiscal Rules in a Highly Distorted Economy

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  • L. Marrattin
  • M. Marzo

Abstract

The objective of this paper is to investigate the optimality of EMU fiscal rules from a welfare perspective. We compute welfare-maximizing feedback coefficients for monetary and fiscal rules in a NK-DSGE with a high number of nominal and real distortions, calibrated on the Euro-area data. The framework includes imperfect competition, costly capital accumulation, consumption habits, price and wage stickiness, distortionary taxation on consumption, labor and capital income. Fiscal policy responds, alternatively, to total deficit, total government liabilities, and a linear combination of both targets. We show that the liabilities rule is welfare superior, but it does not provide enough output stabilization if not coupled with a non-zero response of monetary policy to output; optimal feedback coefficient are larger under debt targeting rather than deficit; under the current specification, a SGP-like rule seems highly suboptimal.

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Paper provided by Dipartimento Scienze Economiche, Universita' di Bologna in its series Working Papers with number 647.

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Date of creation: Oct 2008
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Handle: RePEc:bol:bodewp:647

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  1. Peter N. Ireland, 2001. "Endogenous Money or Sticky Prices?," Boston College Working Papers in Economics, Boston College Department of Economics 499, Boston College Department of Economics.
  2. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4334, C.E.P.R. Discussion Papers.
  3. Argia Sbordone, 2002. "An optimizing model of U.S. wage and price dynamics," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  4. Kim, Jinill & Kim, Sunghyun Henry, 2003. "Spurious welfare reversals in international business cycle models," Journal of International Economics, Elsevier, Elsevier, vol. 60(2), pages 471-500, August.
  5. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 640, Board of Governors of the Federal Reserve System (U.S.).
  6. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  7. Collard, Fabrice & Dellas, Harris, 2005. "Tax distortions and the case for price stability," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(1), pages 249-273, January.
  8. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  9. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  10. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers 12402, National Bureau of Economic Research, Inc.
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Cited by:
  1. Reicher, Claire, 2014. "Systematic fiscal policy and macroeconomic performance: A critical overview of the literature," Economics Discussion Papers 2014-29, Kiel Institute for the World Economy.

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