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Rule of Thumb Consumers, Public Debt and Income Tax

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Raffaele Rossi

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Abstract

This paper analyzes a New Keynesian model with Rule-of-Thumb consumers (ROTC) as in Galí et al.(2007) and a fiscal policy which levies a proportional income tax. We nd that, when the share of ROTC is above a specified threshold and di¤erently from the usual Leeper (1991) result, the determinacy condition requires for both monetary and fiscal policy to be either active of passive. Furthermore we show that the introduction of a set of ROTC can reverse the traditional predictions of a change in government spending on the economy as a whole: under a reasonable parametrization of the model, an increase in government spending can lead, against the common Keynesian wisdom, to a decrease in total output. Finally we point out that with the introduction of a distortive fiscal policy and independently of the parametrization used, private consumption responds negatively to a positive government spending shock.

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Paper provided by Department of Economics, University of Glasgow in its series Working Papers with number 2007_44.

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Date of creation: Aug 2007
Date of revision: Dec 2007
Handle: RePEc:gla:glaewp:2007_44

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Related research
Keywords: Rule-of-thumb-consumers; monetary-fiscal policy interactions; distortive taxation; public spend- ing; private consumption.;

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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  1. Campbell Leith & Simon Wren-Lewis, 2006. "Fiscal Sustainability in a New Keynesian Model," Working Papers 2006_11, Department of Economics, University of Glasgow, revised Nov 2008. [Downloadable!]
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  2. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-34, June. [Downloadable!] (restricted)
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  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February. [Downloadable!] (restricted)
  4. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Carlo Favero & Tommaso Monacelli, 2005. "Fiscal Policy Rules and Regime (In)Stability: Evidence from the U.S," Working Papers 282, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
  6. Linnemann, Ludger, 2006. "The Effect of Government Spending on Private Consumption: A Puzzle?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1715-1735, October. [Downloadable!] (restricted)
  7. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  8. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," CEPR Discussion Papers 1772, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Campell Leith & Leopold von Thadden, 2006. "Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers," Working Paper Series 649, European Central Bank. [Downloadable!]
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  10. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July. [Downloadable!] (restricted)
  11. Roberto Perotti, 1999. "Fiscal Policy In Good Times And Bad," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1399-1436, November. [Downloadable!] (restricted)
  12. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October. [Downloadable!] (restricted)
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