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Fiscal rules and monetary policy in a dynamic stochastic general equilibrium model

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  • Kremer, Jana
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    Abstract

    In this paper an anti-cyclical fiscal policy rule is introduced into a dynamic stochastic general equilibrium model with New-Keynesian features. The rule allows the deficit to deviate from target in proportion to the impact of automatic stabilisers while any additional impact on the deficit, for example on interest expenditure, has to be offset through adjustments of government consumption or taxes. The size of the automatic stabilisers is endogenously determined as the change in the primary deficit that is induced by economic fluctuations for a given tax system. The model is calibrated, and it is shown how the conditions for monetary policy to secure stability and determinacy of the model's equilibrium depend on the fiscal policy rule and, in particular, on the means used to fulfil the rule. It is demonstrated that the Taylor principle holds for reasonable values of the fiscal policy parameter if fiscal policy relies on changes in lump-sum taxes. This runs counter to the benchmark result of Leeper (1991). The same goes for the cases that consumption taxes, profit taxes or government consumption are adjusted to fulfil the fiscal rule. However, if the fiscal rule is met through adjustments of wage or interest tax rates, the range of values of the monetary policy parameter that ensures stability and determinacy change significantly. --

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    Bibliographic Info

    Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2004,35.

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    Date of creation: 2004
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    Handle: RePEc:zbw:bubdp1:2301

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    Related research

    Keywords: dynamic stochastic general equilibrium model; monetary policy rules; fiscal policy rules; stability;

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    1. Jordi Gali & David López-Salido & Javier Valles, 2004. "Understanding the effects of government spending on consumption," International Finance Discussion Papers 805, Board of Governors of the Federal Reserve System (U.S.).
    2. Greenwood, J. & Huffman, G., 1991. "Tax Analysis in A Real Business Cycle Model: On Measuring Harberger Triangles and Okun Gaps," UWO Department of Economics Working Papers 9103, University of Western Ontario, Department of Economics.
    3. Ludger Linnemann, 1999. "Sectoral and aggregate estimates of the cyclical behavior of markups: Evidence from Germany," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 135(3), pages 480-500, September.
    4. Jukka Railavo, 2004. "Stability consequences of fiscal policy rules," Macroeconomics 0404020, EconWPA.
    5. Galí, Jordi & Vallés, Javier & Wolman, Alexander L., 2003. "Understanding the effects of government spending on consumption," CFS Working Paper Series 2004/23, Center for Financial Studies (CFS).
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    7. Hairault, J.O. & Portier, F., 1992. "Money New-Keynesian Macroeconomics and the Business Cycles," Papiers d'Economie Mathématique et Applications 92.32, Université Panthéon-Sorbonne (Paris 1).
    8. Railavo , Jukka, 2004. "Stability consequences of fiscal policy rules," Research Discussion Papers 1/2004, Bank of Finland.
    9. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
    10. Bill Dupor, 2000. "Investment and Interest Rate Policy," Econometric Society World Congress 2000 Contributed Papers 0007, Econometric Society.
    11. Thomas Lubik, 2003. "Investment Spending,Equilibrium Indeterminacy and the Interactions of Monetary and Fiscal Policy," Economics Working Paper Archive 490, The Johns Hopkins University,Department of Economics.
    12. Alfred Maußner, 2002. "Adjustment Costs and Nominal Rigidities in a Small Open Economy," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 222(4), pages 463-489.
    13. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," NBER Working Papers 10253, National Bureau of Economic Research, Inc.
    14. 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.
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    Cited by:
    1. Pytlarczyk, Ernest, 2005. "An estimated DSGE model for the German economy within the euro area," Discussion Paper Series 1: Economic Studies 2005,33, Deutsche Bundesbank, Research Centre.

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