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Monetary-fiscal policy interactions: interdependent policy rule coefficients

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  • Manuel Gonzalez-Astudillo
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    Abstract

    In this paper, we formulate and solve a New Keynesian model with monetary and fiscal policy rules whose coefficients are time-varying and interdependent. We implement time variation in the policy rules by specifying coefficients that are logistic functions of correlated latent factors and propose a solution method that allows for these characteristics. The paper uses Bayesian methods to estimate the policy rules with time-varying coefficients, endogeneity, and stochastic volatility in a limited-information framework. Results show that monetary policy switches regime more frequently than fiscal policy, and that there is a non-negligible degree of interdependence between policies. Policy experiments reveal that contractionary monetary policy lowers inflation in the short run and increases it in the long run. Also, lump-sum taxes affect output and inflation, as the literature on the fiscal theory of the price level suggests, but the effects are attenuated with respect to a pure fiscal regime.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2013-58.

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    Date of creation: 2013
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    Handle: RePEc:fip:fedgfe:2013-58

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