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Optimal Fiscal and Monetary Rules in Normal and Abnormal Times

Author

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  • Cantore, C. M.
  • Levine, P.
  • Melina, G.
  • Pearlman, J.

Abstract

We examine fiscal-monetary interactions in a New-Keynesian model with deep habits, distortionary taxes and a sovereign risk premium for government debt. Deep habits crucially affect the fiscal transmission mechanism in that these lead to a counter-cyclical mark-up, boosting the size of a demand-driven output expansion with important consequences for monetary and fiscal policy. We employ Bayesian estimates of the model to compute optimal monetary and fiscal policy first in `normal times' with debt starting at its steady state and then in a crisis period with a much higher initial debt-GDP ratio. Policy is conducted in terms of optimal commitment, time consistent and simple Taylor-type rules. Welfare calculations and impulse responses indicate that the ability of the simple rules to closely mimic the Ramsey optimal policy, observed in the literature with optimal monetary policy alone, is still a feature of optimal policy with fiscal instruments, but only with `passive' fiscal policy. For crisis management we find some support for slow consolidation with a more active role for tax increases rather than a decrease in government spending.

Suggested Citation

  • Cantore, C. M. & Levine, P. & Melina, G. & Pearlman, J., 2013. "Optimal Fiscal and Monetary Rules in Normal and Abnormal Times," Working Papers 13/16, Department of Economics, City University London.
  • Handle: RePEc:cty:dpaper:13/16
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    References listed on IDEAS

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    1. Baron, David P. & Ferejohn, John A., 1989. "Bargaining in Legislatures," American Political Science Review, Cambridge University Press, vol. 83(4), pages 1181-1206, December.
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    Cited by:

    1. Miller, Luis & Montero, Maria & Vanberg, Christoph, 2018. "Legislative bargaining with heterogeneous disagreement values: Theory and experiments," Games and Economic Behavior, Elsevier, vol. 107(C), pages 60-92.
    2. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2015. "Optimal fiscal and monetary policy action in a closed economy," Economic Modelling, Elsevier, vol. 48(C), pages 175-188.
    3. Reicher, Claire, 2014. "Systematic fiscal policy and macroeconomic performance: A critical overview of the literature," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 8, pages 1-37.
    4. Costantini, Mauro & Fragetta, Matteo & Melina, Giovanni, 2014. "Determinants of sovereign bond yield spreads in the EMU: An optimal currency area perspective," European Economic Review, Elsevier, vol. 70(C), pages 337-349.
    5. Cesar Martinelli & Thomas R. Palfrey, 2017. "Communication and Information in Games of Collective Decision: A Survey of Experimental Results," Working Papers 1065, George Mason University, Interdisciplinary Center for Economic Science.
    6. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2017. "Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence," International Journal of Central Banking, International Journal of Central Banking, vol. 13(4), pages 259-306, December.
    7. Paulo Vieira & Celsa Machado & Ana Paula Ribeiro, 2016. "Optimal Fiscal Simple Rules for Small and Large Countries of a Monetary Union," EcoMod2016 9685, EcoMod.
    8. George Economides & Anastasio Xepapadeas, 2019. "The effects of climate change on a small open economy," CESifo Working Paper Series 7582, CESifo.
    9. George Economides & Apostolis Philippopoulos & Petros Varthalitis, 2016. "Monetary Union, Even Higher Integration, or Back to National Currencies?," CESifo Economic Studies, CESifo, vol. 62(2), pages 232-255.
    10. Sakkas, Stelios & Varthalitis, Petros, 2018. "The (intertemporal) equity-efficiency trade-off of fiscal consolidation," MPRA Paper 90983, University Library of Munich, Germany.
    11. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo.
    12. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2012. "On the optimal mix of fiscal and monetary policy actions," Working Papers 150, Bank of Greece.

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    More about this item

    Keywords

    optimal fiscal and monetary rules; fiscal consolidation; deep habits;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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