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Fiscal policy effectiveness and neutrality results in a non-Ricardian world

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Author Info
Carsten Detken () (European Central Bank, Directorate General Research)

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Abstract

The paper introduces monetary and fiscal regimes into a Blanchard-Weil overlapping generations model. Contrary to intuition, it is shown that fiscal policy becomes more effective, the less the central bank monetises government debt. Furthermore, there is a degree of debt monetisation at which Ricardian equivalence seems to hold in this “non-Ricardian” model, as fiscal policy is neutral with respect to agent’s net wealth. At the origin of these results are the opposite intergenerational wealth effects of money and debt financing. Since, on average, central bank independence increased through EMU, the analysis suggests that fiscal policy might have become a more powerful instrument for euro-area countries. It is further argued that given the Stability and Growth Pact, governments will find it wise to run budget positions ‘close to balance or in surplus’ in order to maintain the increased fiscal policy effectiveness.

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Paper provided by European Central Bank in its series Working Paper Series with number 3.

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Length: 29 pages
Date of creation: May 1999
Date of revision:
Handle: RePEc:ecb:ecbwps:19990003

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Related research
Keywords: monetary and fiscal policy regimes; fiscal policy effectiveness; Ricardian equivalence; central bank independence; Stability and Growth Pact.;

Find related papers by JEL classification:
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization

References listed on IDEAS
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  1. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
    Other versions:
  2. Liviatan, Nissan, 1982. "Neutrality of government bonds reconsidered," Journal of Public Economics, Elsevier, vol. 19(2), pages 261-270, November. [Downloadable!] (restricted)
  3. B. Douglas Bernheim, 1987. "Ricardian Equivalence: An Evaluation of Theory and Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 263-316 National Bureau of Economic Research, Inc. [Downloadable!]
    Other versions:
  4. Evans, Paul, 1991. "Is Ricardian Equivalence a Good Approximation?," Economic Inquiry, Oxford University Press, vol. 29(4), pages 626-44, October.
  5. Beetsma, R.M.W.J. & Uhlig, H., 1997. "An analysis of the "stability pact"," Discussion Paper 59, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  6. Fischer, Stanley, 1979. "Capital Accumulation on the Transition Path in a Monetary Optimizing Model," Econometrica, Econometric Society, vol. 47(6), pages 1433-39, November. [Downloadable!] (restricted)
  7. Weil, Philippe, 1991. "Is Money Net Wealth?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(1), pages 37-53, February. [Downloadable!] (restricted)
  8. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Thomas J. Sargent, 1982. "Beyond demand and supply curves in macroeconomics," Staff Report 77, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  10. Barry Eichengreen & Charles Wyplosz, 1998. "The Stability Pact: more than a minor nuisance?," Economic Policy, CEPR, CES, MSH, vol. 13(26), pages 65-113, 04. [Downloadable!] (restricted)
  11. Buti, Marco & Franco, Daniele & Ongena, Hedwig, 1998. "Fiscal Discipline and Flexibility in EMU: The Implementation of the Stability and Growth Pact," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 81-97, Autumn.
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  13. Buiter, Willem H & Kletzer, Kenneth, 1990. "Reflections on the Fiscal Implications of a Common Currency," CEPR Discussion Papers 418, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  16. Roubini, Nouriel & Sachs, Jeffrey D., 1989. "Political and economic determinants of budget deficits in the industrial democracies," European Economic Review, Elsevier, vol. 33(5), pages 903-933, May. [Downloadable!] (restricted)
  17. Liviatan, Nissan, 1988. "On the Interaction between Monetary and Fiscal Policies under Perfect Foresight," Oxford Economic Papers, Oxford University Press, vol. 40(1), pages 193-203, March. [Downloadable!] (restricted)
  18. Buiter, W.H. & Corsetti, G. & Roubini, N., 1992. "Excessive Deficits: Sense and Nonsence in the Treaty of Maastricht," Papers 674, Yale - Economic Growth Center.
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  19. Nouriel Roubini & Jeffrey Sachs, 1988. "Political and Economic Determinants of Budget Deficits in the IndustrialDemocracies," NBER Working Papers 2682, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  20. Weil, Philippe, 1989. "Overlapping families of infinitely-lived agents," Journal of Public Economics, Elsevier, vol. 38(2), pages 183-198, March. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Carsten Detken & Vincent Brousseau, 2001. "Monetary policy and fears of financial instability," Working Paper Series 089, European Central Bank. [Downloadable!]
  2. George W. Evans & Seppo Honkapohja, 2002. "Monetary policy; expectations and commitment," Working Paper Series 124, European Central Bank. [Downloadable!]
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  3. Paul Hiebert & Massimo Rostagno & Javier J. Perez, 2002. "Debt reduction and automatic stabilisation," Working Paper Series 189, European Central Bank. [Downloadable!]
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  4. Jean-Bernard Chatelain & Andrea Generale & Ignacio Hernando & Philip Vermeulen & Ulf von Kalckreuth, 2001. "Firm investment and monetary policy transmission in the Euro area," Working Paper Series 112, European Central Bank. [Downloadable!]
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  5. Bernhard Winkler, 2000. "Which kind of transparency? On the need for clarity in monetary policy-making," Working Paper Series 26, European Central Bank. [Downloadable!]
  6. Michael Ehrmann & Frank Smets, 2001. "Uncertain potential output: implications for monetary policy," Working Paper Series 059, European Central Bank. [Downloadable!]
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  7. Eugenio Gaiotti & Andrea Generale, 2001. "Does monetary policy have asymmetric effects? A look at the investment decisions of Italian firms," Working Paper Series 110, European Central Bank. [Downloadable!]
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  8. Livio Stracca & Ali Al-Nowaihi, 2002. "Non-standard Central Bank loss functions; skewed risks; and certainty equivalence," Working Paper Series 129, European Central Bank. [Downloadable!]
  9. Miguel Casares, 2001. "Business cycle and monetary policy analysis in a structural sticky-price model of the euro area," Working Paper Series 49, European Central Bank. [Downloadable!]
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  10. Gonzalo Camba-Mendez & George Kapetanios, 2001. "Spectral based methods to identify common trends and common cycles," Working Paper Series 062, European Central Bank. [Downloadable!]
  11. Gian Maria Tomat, 2002. "Durable goods; price indexes and quality change: an application to automobile prices in Italy, 1988-1998," Working Paper Series 118, European Central Bank. [Downloadable!]
  12. Barbara Annicchiarico, 2003. "Government deficits, wealth effects and the price level in an optimizing model," Working Paper Series 285, European Central Bank. [Downloadable!]
  13. Carsten Detken & Vítor Gaspar & Bernhard Winkler, 2005. "On Prosperity and Posterity: The Need for Fiscal Discipline in a Monetary Union," Working Papers de Economia (Economics Working Papers) 30, Departamento de Economia, Gestão e Engenharia Industrial, Universidade de Aveiro. [Downloadable!]
    Other versions:
  14. Fiorella de Fiore, 2000. "The optimal inflation tax when taxes are costly to collect," Working Paper Series 38, European Central Bank. [Downloadable!]
  15. Fiorella de Fiore, 2000. "Can indeterminacy explain the short-run non-neutrality of money?," Working Paper Series 32, European Central Bank. [Downloadable!]
  16. S. Sgherri, 2000. "The fiscal dimension of a common monetary policy: results with a non-Ricardian global model," WO Research Memoranda (discontinued) 615, Netherlands Central Bank, Research Department. [Downloadable!]
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  17. Andreas Beyer & Roger E. A. Farmer, 2002. "Natural rate doubts," Working Paper Series 121, European Central Bank. [Downloadable!]
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  18. Stefan Straetmans & Casper G. De Vries & Philipp Hartmann, 2001. "Asset market linkages in crisis periods," Working Paper Series 071, European Central Bank. [Downloadable!]
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  19. Andreas Worms, 2001. "The reaction of bank lending to monetary policy measures in Germany," Working Paper Series 096, European Central Bank. [Downloadable!]
  20. Seppo Honkapohja & Kaushik Mitra, 2002. "Learning stability in economics with heterogenous agents," Working Paper Series 120, European Central Bank. [Downloadable!]
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