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Monetary consequences of alternative fiscal policy rules

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  • Railavo, Jukka

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    (Bank of Finland Research)

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    Abstract

    In this paper we analyse the monetary impact of alternative fiscal policy rules using the debt and deficit, both mentioned as measures of fiscal policy performance in the Stability and Growth Pact (SGP). We use a New Keynesian model, with endogenous labour supply, distortionary taxation and no private capital. The economy is hit by two fundamental shocks: demand and supply shocks, which are orthogonal to each other. Monetary policy is conducted by an independent central bank that will optimise. Under discretionary monetary policy the size of the inflation bias depends on the fiscal policy regime. Using the timeless perspetive approach to precommitment, output persistence increase compared to the discretionary case. The result holds with the alternative fiscal policy rules, and inflation and output persistence reflects the economic data. With the deficit rules, the autocorrelation of the tax rate is near unity irrespective of the monetary policy regime, and irrespective of the fiscal policy parameters and targets.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0420.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 20/2004.

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    Length: 33 pages
    Date of creation: 13 Oct 2004
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2004_020

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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; optimal monetary policy; fiscal policy; policy coordination;

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    References

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    1. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers, Stockholm University, Institute for International Economic Studies 666, Stockholm University, Institute for International Economic Studies.
    2. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
    3. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, Elsevier, vol. 26(2), pages 183-209, June.
    4. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(5), pages 940-71, October.
    5. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
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    7. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 27(1), pages 129-147, February.
    8. Svensson, Lars E O, 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1249, C.E.P.R. Discussion Papers.
    9. Railavo, Jukka, 2003. "Effects of the supply-side channel on stabilisation properties of policy rules," Research Discussion Papers, Bank of Finland 34/2003, Bank of Finland.
    10. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
    11. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
    12. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
    14. Kosuke Aoki & Kalin Nikolov, 2004. "Rule-based monetary policy under central bank learning," Bank of England working papers 235, Bank of England.
    15. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
    16. Railavo , Jukka, 2004. "Stability consequences of fiscal policy rules," Research Discussion Papers, Bank of Finland 1/2004, Bank of Finland.
    17. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(3), pages 575-607, April.
    18. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
    19. Jukka Railavo, 2004. "Stability consequences of fiscal policy rules," Macroeconomics, EconWPA 0404020, EconWPA.
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    Cited by:
    1. Paolo Zagaglia, 2007. "Operational Fiscal and Monetary Policy with Staggered Wage and Price Dynamics," Finnish Economic Papers, Finnish Economic Association, Finnish Economic Association, vol. 20(2), pages 121-138, Autumn.

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