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Investment Spending,Equilibrium Indeterminacy and the Interactions of Monetary and Fiscal Policy

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  • Thomas Lubik

Abstract

This paper investigates determinacy of equilibrium in a canonical New Keynesian model under different monetary and fiscal policy rules. It is shown that a simple monetary rule that responds aggressively to inflation is a necessary condition for equilibrium determinacy, when fiscal policy is accommodating. If there is a high degree of structural distortions in the economy, then the interesting possibility arises that both aggressive monetary and fiscal policies are required to guarantee existence. When investment adjustment costs are introduced, the monetary and fiscal policy dichotomy is in principle maintained. The determinacy region is, however, highly dependent on the degree of distortion in the economy. The more prices are sticky, and the less competitive firms are, the economy is likely to exhibit indeterminacy even if monetary policy is active.

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Bibliographic Info

Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 490.

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Date of creation: Jan 2003
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Handle: RePEc:jhu:papers:490

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References

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  1. Lubik, Thomas A. & Marzo, Massimiliano, 2007. "An inventory of simple monetary policy rules in a New Keynesian macroeconomic model," International Review of Economics & Finance, Elsevier, vol. 16(1), pages 15-36.
  2. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
  3. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Paper 0009, Federal Reserve Bank of Cleveland.
  4. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "Monetary policy and multiple equilibria," Finance and Economics Discussion Series 1998-29, Board of Governors of the Federal Reserve System (U.S.).
  5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  6. Roger E.A. Farmer, 1996. "Money In A Real Business Cycle Model," UCLA Economics Working Papers 757, UCLA Department of Economics.
  7. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
  8. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  9. 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.
  10. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
  11. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  12. Frank Schorfheide & Thomas A. Lubik, 2003. "Estimating Monetary Policy Rules in Small Open Economies: A Structural Approach," Computing in Economics and Finance 2003 225, Society for Computational Economics.
  13. 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.
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Cited by:
  1. Thomas Lubik & Massimiliano Marzo, 2003. "An Inventory of Simple Monetary Policy Rules in a New Keynesian Macroeconomic Model," Economics Working Paper Archive 500, The Johns Hopkins University,Department of Economics.
  2. Seiya Fujisaki & Kazuo Mino, 2008. "Income Taxation, Interest-Rate Control and Macroeconomic Stability with Balanced-Budget," Discussion Papers in Economics and Business 08-20, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  3. 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.
  4. Tommy Sveen & Lutz Weinke, 2004. "Firm-specific investment, sticky prices and the Taylor principle," Economics Working Papers 780, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Marco Ratto, 2008. "Analysing DSGE Models with Global Sensitivity Analysis," Computational Economics, Society for Computational Economics, vol. 31(2), pages 115-139, March.

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