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Optimal fiscal feedback on debt in an economy with nominal rigidities

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Tatiana Kirsanova
Simon Wren-Lewis

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Abstract

We examine the impact of different degrees of fiscal feedback on debt in an economy with nominal rigidities where monetary policy is optimal. We look at the extent to which different degrees of fiscal feedback enhance or detract from the ability of the monetary authorities to stabilize output and inflation. Using an objective function derived from utility, we find the optimal level of fiscal feedback to be small. A clear discontinuity exists in the behavior of monetary policy and welfare on either side of this optimal level. As the extent of fiscal feedback increases, optimal monetary policy becomes less active because fiscal feedback tends to deflate inflationary shocks. However, this fiscal stabilization is less efficient than monetary policy, so welfare declines. In contrast, if fiscal feedback falls below some critical value, optimal monetary policy becomes strongly passive, and this passive monetary policy leads to a sharp deterioration in welfare.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2007-26.

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Date of creation: 2007
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Handle: RePEc:fip:fedawp:2007-26

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  23. Tatiana Kirsanova & Simon Wren-Lewis, 2007. "Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," Economics Series Working Papers 306, University of Oxford, Department of Economics. [Downloadable!]
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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. Bill Martin, 2007. "Fiscal Policy in a Stock-Flow consistent (SFC) Model: A Comment," ESRC Centre for Business Research - Working Papers wp341, ESRC Centre for Business Research. [Downloadable!]
  2. Tatiana Kirsanova & Simon Wren-Lewis, 2007. "Optimal fiscal feedback on debt in an economy with nominal rigidities," Working Paper 2007-26, Federal Reserve Bank of Atlanta. [Downloadable!]
    Other versions:
  3. Tatiana Kirsanova & David Vines & Simon Wren-Lewis, 2007. "When Inflation Persistence Really Matters: Two examples," Kiel Working Papers 1351, Kiel Institute for the World Economy. [Downloadable!]
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