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Modelling Monetary and Fiscal Policy in the US: A Cointegration Approach

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  • J. James Reade

Abstract

As governments and economists worldwide reflect on the unprecedented peacetime build-ups of government deficits and debts since 2008 and the Great Recession, the importance of fiscal and monetary policy interactions and their sustainability is key. This involves both thorough theoretical and careful econometric analysis. This paper provides the latter. We use multivariate cointegration methods to investigate monetary and fiscal interactions using the example of the United States since the early 1980s. Using survey data for inflation expectations, we find that monetary policymaking is heavily forward looking, and passive in the sense that it responds to policy rule. Fiscal policy is found to be active in that it does not respond to the fiscal policy rule discovered in the data. Entering into debates on the efficacy of fiscal policy, we find that in the long-term fiscal deficits are very harmful to growth, but in the short run fiscal stimuli can be effective in restoring the economy to equilibrium. The interactions between the two policy spheres appear somewhat limted in that neither policy tool enters the policy rule of the other policy sphere, but the more passive monetary policy does movwe in reaction to fiscal policy movements - the two policy spheres are complementary in that both respond in the same direction to revive and restrain the economy in downturns and boom times respectively.

Suggested Citation

  • J. James Reade, 2011. "Modelling Monetary and Fiscal Policy in the US: A Cointegration Approach," Discussion Papers 11-02, Department of Economics, University of Birmingham.
  • Handle: RePEc:bir:birmec:11-02
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    File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/11-02.pdf
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    References listed on IDEAS

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    1. Joseph G. Haubrich, 2009. "A new approach to gauging inflation expectations," Economic Commentary, Federal Reserve Bank of Cleveland, issue Aug.
    2. Hughes Hallett, Andrew, 2005. "In Praise of Fiscal Restraint and Debt Rules. What the Euro Zone Might Do Now," CEPR Discussion Papers 5043, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Daly, Hounaida & Smida, Mounir, 2013. "Interaction entre politique monétaire et politique budgétaire:Cas de la Grèce
      [Fiscal and Monetary Policy Interactions : The Greece Case]
      ," MPRA Paper 45931, University Library of Munich, Germany.
    2. Daly, Hounaida & Smida, Mounir, 2014. "Fiscal Theory of Price Level," MPRA Paper 60142, University Library of Munich, Germany.
    3. repec:ehl:lserod:56406 is not listed on IDEAS
    4. Daly, Hounaida & Smida, Mounir, 2013. "La coordination des politiques monétaire et budgétaire: Aperçu théorique
      [Coordination of monetary and fiscal policies: Theoretical Overview]
      ," MPRA Paper 48020, University Library of Munich, Germany.

    More about this item

    Keywords

    Monetary policy; fiscal policy; policy interactions; cointegrated VAR method;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics

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