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Optimal Fiscal Stabilisation through Government Spending

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  • Fabian Eser

    ()
    (Nuffield College, Oxford University, Oxford.)

Abstract

This paper examines under what conditions fiscal policy in the form of government spending should contribute to macroeconomic stabilisation. To this end optimal fiscal targeting rules minimising the microfounded social loss are examined in the following settings. Firstly, for the benchmark New Keynesian model, where monetary policy is unconstrained, a neutrality result for fiscal obtains: fiscal policy should not respond to any shocks. Secondly, if monetary policy is constrained to follow a Taylor rule, a stabilisation role for fiscal policy emerges. Fiscal policy should 'lean against' inflation and be countercyclical relative to output. Crucially, the Taylor principle is shown to remain the key requirement on policy to guarantee equilibrium determinacy. Thirdly, the fiscal targeting rule obtained under a Taylor rule is shown to be optimal, too, when policy is optimal but subject to monetary frictions. Thus, there is a stabilisation role for government spending under monetary frictions, changing the role of monetary and fiscal policy fundamentally.

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Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2009-W14.

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Length: 34 pages
Date of creation: 13 Oct 2009
Date of revision:
Handle: RePEc:nuf:econwp:0914

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Web page: http://www.nuff.ox.ac.uk/economics/

Related research

Keywords: Monetary Policy; Fiscal Policy; Macroeconomic Stabilisation; Discretion; Dynamic General Equilibrium; Sticky Prices; Monetary Frictions; Equilibrium Determinacy;

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Cited by:
  1. Leith, Campbell & Wren-Lewis, Simon, 2009. "When is Monetary Policy All we Need?," SIRE Discussion Papers 2009-25, Scottish Institute for Research in Economics (SIRE).

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