Fiscal Sustainability in a New Keynesian Model - Additional Appendix
AbstractRecent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady-state debt to follow a random walk. Leith and Wren-Lewis (2012) consider the nature of the timeinconsistency involved in such a policy and its implication for discretionary policy-making. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady-state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government’s objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt-stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi-commitment policy which allows for different probabilities of reneging on past promises. This on-line Appendix extends the results of this paper.
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Bibliographic InfoPaper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2012_13.
Date of creation: Sep 2012
Date of revision:
New Keynesian Model; Government Debt; Monetary Policy; Fiscal Policy; Credibility.;
Find related papers by JEL classification:
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- 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; Treasury Policy
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- Campbell Leith & Simon Wren-Lewis, 2006.
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2006_11, Business School - Economics, University of Glasgow, revised Nov 2008.
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- Andrea Tambalotti & Ernst Schaumburg, 2004.
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- Ernst Schaumburg & Andrea Tambalotti, 2003. "An investigation of the gains from commitment in monetary policy," Staff Reports 171, Federal Reserve Bank of New York.
- Ernst Schaumburg & Andrea Tambalotti, 2003. "An Investigation of the Gains from Commitment in Monetary Policy," Macroeconomics 0302004, EconWPA.
- Christoph Himmels & Tatiana Kirsanova, 2011.
"Expectations Traps and Monetary Policy with Limited Commitment,"
1102, Exeter University, Department of Economics.
- Himmels, Christoph & Kirsanova, Tatiana, 2011. "Expectations Traps and Monetary Policy with Limited Commitment," MPRA Paper 29208, University Library of Munich, Germany.
- Debortoli, Davide & Nunes, Ricardo, 2010. "Fiscal policy under loose commitment," Journal of Economic Theory, Elsevier, vol. 145(3), pages 1005-1032, May.
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