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Government Spending and the Taylor Principle


This paper explores how government size affects the scope for equilibrium indeterminacy in a New Keynesian economy, where part of the population live hand-to-mouth. The main result is that a higher level of public consumption is likely to generate indeterminacy and render the Taylor principle insufficient as criterion for equilibrium uniqueness. This holds even though fiscal policy serves to reduce swings in current income. Only if government consumption is a substitute for private consumption, will it narrow the scope for indeterminacy. Hence monetary policy should be conducted with an eye to the amount and composition of government consumption. Copyright (c) 2009 The Ohio State University.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 41 (2009)
Issue (Month): 1 (02)
Pages: 57-77

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Handle: RePEc:mcb:jmoncb:v:41:y:2009:i:1:p:57-77
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  9. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  10. Schmitt-Grohe, Stephanie & Uribe, Martin, 1997. "Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 976-1000, October.
  11. Karras, Georgios, 1994. "Government Spending and Private Consumption: Some International Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 9-22, February.
  12. Roisland, Oistein, 2003. "Capital income taxation, equilibrium determinacy, and the Taylor principle," Economics Letters, Elsevier, vol. 81(2), pages 147-153, November.
  13. Benhabib, Jess & Eusepi, Stefano, 2005. "The design of monetary and fiscal policy: A global perspective," Journal of Economic Theory, Elsevier, vol. 123(1), pages 40-73, July.
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  25. Fatás, Antonio & Mihov, Ilian, 1999. "Government Size and Automatic Stabilizers: International and Intranational Evidence," CEPR Discussion Papers 2259, C.E.P.R. Discussion Papers.
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