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When is Monetary Policy All we Need?

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  • Leith, Campbell
  • Wren-Lewis, Simon

Abstract

We consider optimal monetary and scal policies in a New Keynesian model of a small open economy with sticky prices and wages. In this benchmark setting monetary policy is all we need - analytical results demonstrate that variations in government spending should play no role in the stabilization of shocks. In extensions we show, rstly, that this is even when true when allowing for in ation inertia through backward-looking rule-of-thumb price and wage-setting, as long as there is no discrepancy between the private and social evaluation of the marginal rate of substitution between consumption and leisure. Secondly, the optimal neutrality of government spending is robust to the issuance of public debt. In the presence of debt government spending will deviate from the optimal steady-state but only to the extent required to cover the deficit, not to provide any additional macroeconomic stabilization. However, unlike government spending variations in tax rates can play a complementary role to monetary policy, as they change relative prices rather than demand.

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Bibliographic Info

Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2009-25.

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Date of creation: 2009
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Handle: RePEc:edn:sirdps:111

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Keywords: Behaviour; Sticky Prices; Sticky wages; Monetary Policy; Fiscal Policy; Macroeconomic Stabilization; Dynamic General Equilibrium; Rule-of-Thumb; Debt; Countercyclical Policy;

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References

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  1. Campbell Leith & Simon Wren‐Lewis, 2013. "Fiscal Sustainability in a New Keynesian Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(8), pages 1477-1516, December.
  2. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," CEPR Discussion Papers 2942, C.E.P.R. Discussion Papers.
  3. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  4. Pontiggia, Dario, 2007. "Inflation persistence and optimal positive long-run inflation," MPRA Paper 3274, University Library of Munich, Germany.
  5. Gianluca Benigno & Bianca De Paoli, 2009. "On the international dimension of fiscal policy," LSE Research Online Documents on Economics 28515, London School of Economics and Political Science, LSE Library.
  6. Kevin D. Sheedy, 2007. "Robustly Optimal Monetary Policy," CEP Discussion Papers dp0840, Centre for Economic Performance, LSE.
  7. Leith, Campbell & Simon Wren-Lewis, 2002. "Compatibility Between Monetary and Fiscal Policy Under EMU," Royal Economic Society Annual Conference 2002 124, Royal Economic Society.
  8. Kirsanova, Tatiana & Satchi, Mathan & Vines, David & Wren-Lewis, Simon, 2006. "Optimal Fiscal Policy Rules in a Monetary Union," CEPR Discussion Papers 5533, C.E.P.R. Discussion Papers.
  9. Gali­, Jordi & Monacelli, Tommaso, 2008. "Optimal monetary and fiscal policy in a currency union," Journal of International Economics, Elsevier, vol. 76(1), pages 116-132, September.
  10. Leith, Campbell & Malley, Jim, 2005. "Estimated general equilibrium models for the evaluation of monetary policy in the US and Europe," European Economic Review, Elsevier, vol. 49(8), pages 2137-2159, November.
  11. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  12. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  13. Fabian Eser, 2009. "Optimal Fiscal Stabilisation through Government Spending," Economics Papers 2009-W14, Economics Group, Nuffield College, University of Oxford.
  14. Sven Jari Stehn & David Vines, 2008. "Strategic Interactions Between An Independent Central Bank and a Myopic Government with Government Debt," IMF Working Papers 08/164, International Monetary Fund.
  15. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2006. "Should Central Banks Target Consumer Prices or the Exchange Rate?," Economic Journal, Royal Economic Society, vol. 116(512), pages F208-F231, 06.
  16. Tatiana Kirsanova & Simon Wren-Lewis, 2007. "Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," Discussion Papers 0705, Exeter University, Department of Economics.
  17. David Vines & Sven Jari Stehn, 2007. "Debt Stabilization Bias and the Taylor Principle," IMF Working Papers 07/206, International Monetary Fund.
  18. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  19. Jordi Galí, 2007. "Constant interest rate projections without the curse of indeterminacy," Economics Working Papers 1057, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 2008.
  20. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
  21. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Is it a sin for the central bank to help reduce debt?
    by Mainly Macro in Mainly Macro on 2012-11-29 23:15:00
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Cited by:
  1. Fabian Eser, 2009. "Optimal Fiscal Stabilisation through Government Spending," Economics Papers 2009-W14, Economics Group, Nuffield College, University of Oxford.
  2. Stefano Gnocchi, 2013. "Monetary Commitment and Fiscal Discretion: The Optimal Policy Mix," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 187-216, April.
  3. Campbell Leith & Simon Wren-Lewis, 2010. "Discretionary policy in a monetary union with sovereign debt," Working Papers 2010_23, Business School - Economics, University of Glasgow.
  4. Chen, Xiaoshan & Kirsanova, Tatiana & Leith, Campbell, 2013. "How Optimal is US Monetary Policy?," Stirling Economics Discussion Papers 2013-05, University of Stirling, Division of Economics.
  5. Leith, Campbell & Moldovan, Ioana & Rossi, Raffaele, 2009. "Monetary and Fiscal Policy under Deep Habits," SIRE Discussion Papers 2009-47, Scottish Institute for Research in Economics (SIRE).
  6. Eric M. Leeper, 2009. "Anchoring Fiscal Expectations," NBER Working Papers 15269, National Bureau of Economic Research, Inc.
  7. Simon Wren-Lewis, 2011. "Comparing the delegation of monetary and fiscal policy," Economics Series Working Papers 540, University of Oxford, Department of Economics.

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