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Fluctuating Macro Policies and the Fiscal Theory

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Troy Davig
Eric M. Leeper

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Abstract

This paper estimates regime-switching rules for monetary policy and tax policy over the post-war period in the United States and imposes the estimated policy process on a calibrated dynamic stochastic general equilibrium model with nominal rigidities. Decision rules are locally unique and produce a stationary long-run rational expectations equilibrium in which (lump-sum) tax shocks always affect output and inflation. Tax non-neutralities in the model arise solely through the mechanism articulated by the fiscal theory of the price level. The paper quantifies that mechanism and finds it to be important in U.S. data, reconciling a popular class of monetary models with the evidence that tax shocks have substantial impacts. Because long-run policy behavior determines existence and uniqueness of equilibrium, in a regime-switching environment more accurate qualitative inferences can be gleaned from full-sample information than by conditioning on policy regime.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11212.

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Date of creation: Mar 2005
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Handle: RePEc:nbr:nberwo:11212

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Find related papers by JEL classification:
E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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  1. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  2. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June. [Downloadable!] (restricted)
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