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Stability consequences of fiscal policy rules

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  • Railavo , Jukka

    ()
    (Bank of Finland Research)

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    Abstract

    Using an optimisation-based model with endogenous labour supply and a proportional tax rate, we compare the stabilising properties of different fiscal policy rules. The economy is affected by shocks from both government spending and technology. The fiscal policy rule can be based on government liabilities or the government budget deficit. As both are given as measures of fiscal policy performance in the Stability and Growth Pact (SGP), we also use a fiscal policy rule based on the combination of the two. We compare the accounting definition of deficit with the economic definition which takes inflation into account. The fiscal policy rule based on debt, with monetary policy consistent with the Taylor principle, results in an unstable solution. However, a fiscal policy rule based on deficit produces stable solutions with a wide range of fiscal policy parameters. Moreover, we find that putting more weight on the deficit than the debt in the fiscal policy rule creates less cyclical responses to shocks. Finally we find out that the SGP definition of deficit performs as well as the real deficit based on the government budget constraint.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0401.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 1/2004.

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    Length: 45 pages
    Date of creation: 20 Jan 2004
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2004_001

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    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: inflation; fiscal and monetary policy; stabilisation;

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    References

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    Cited by:
    1. Kilponen , Juha & Kinnunen , Helvi & Ripatti , Antti, 2006. "Population ageing in a small open economy – some policy experiments with a tractable general equilibrium model," Research Discussion Papers 28/2006, Bank of Finland.
    2. Marattin, Luigi & Marzo, Massimiliano & Zagaglia, Paolo, 2011. "A welfare perspective on the fiscal–monetary policy mix: The role of alternative fiscal instruments," Journal of Policy Modeling, Elsevier, vol. 33(6), pages 920-952.
    3. Jukka Railavo, 2005. "Monetary Concequences of Alternative Fiscal Policy Rules," Computing in Economics and Finance 2005 145, Society for Computational Economics.
    4. Kremer, Jana, 2004. "Fiscal rules and monetary policy in a dynamic stochastic general equilibrium model," Discussion Paper Series 1: Economic Studies 2004,35, Deutsche Bundesbank, Research Centre.
    5. Railavo, Jukka, 2004. "Monetary consequences of alternative fiscal policy rules," Research Discussion Papers 20/2004, Bank of Finland.
    6. Rafael Domenech & Javier Andres, 2005. "Fiscal Rules and Macroeconomic Stability," Working Papers 0501, International Economics Institute, University of Valencia, revised Nov 2005.

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