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Designing monetary and Fiscal policy rules in a New Keynesian model with rule-of-thumb consumers

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  • Raffaele Rossi

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Abstract

This paper develops a small New Keynesian model augmented with a steady state level of public debt and a share of rule-of-thumb consumers (ROTC henceforth) as in Gali' et al. (2004; 2007). The paper focuses on the consequences for the design of monetary and fiscal rules, of the bifurcation generated by the presence of ROTC on the demand side of the economy, in the absence of Ricardian equivalence. We find that, when fiscal policy follows a balanced budget rule, the amount of ROTC determines whether an active and/or a passive monetary policy in the sense of Leeper (1991) guarantees determinacy. When short run public debt assets are introduced, the amount of ROTC determines whether equilibrium determinacy requires a mix of active (passive) monetary policy and a passive (active) fiscal policy or a mix where policies are both active or passive. This set of equilibria has the potential to explain the empirical evidence on the U.S. postwar data on monetary and fiscal policy interactions.

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File URL: http://dipeco.economia.unimib.it/repec/pdf/mibwpaper174.pdf
File Function: First version, 2009
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Bibliographic Info

Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 174.

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Length: 51 pages
Date of creation: Nov 2009
Date of revision: Nov 2009
Handle: RePEc:mib:wpaper:174

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Keywords: Rule-of-thumb consumers; monetary-?scal iteractions; balanced budget rule; Taylor principle; active-passive policy mix;

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