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Government Spending and the Taylor Principle

  • Gisle James Natvik

    ()

    (University of Oslo and Norges Bank (Central Bank of Norway))

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. I find that in this framework, a larger public sector may widen the scope for self-fulfilling prophecies to occur. This takes place even though taxes serve to reduce swings in current income. In general, government provision of goods that are Edgeworth substitutes for private consumption tend to narrow the scope for indeterminacy, while government goods that are Edgeworth complements for private consumption increase the problem of indeterminacy. Hence monetary policy should be conducted with an eye to the amount and composition of government consumption.

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Paper provided by Norges Bank in its series Working Paper with number 2006/11.

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Length: 41 pages
Date of creation: 11 Dec 2006
Date of revision:
Handle: RePEc:bno:worpap:2006_11
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  1. Galí, Jordi & Perotti, Roberto, 2003. "Fiscal Policy and Monetary Integration in Europe," CEPR Discussion Papers 3933, C.E.P.R. Discussion Papers.
  2. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  3. 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.
  4. Florin O. Bilbie, 2005. "Limited Asset Markets Participation, Monetary Policy and (Inverted) Keynesian Logic," Economics Series Working Papers 2005-W09, University of Oxford, Department of Economics.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  6. Javier Andrés & Rafael Doménech, 2003. "Automatic stabilizers, fiscal rules and macroeconomic stability," Banco de Espa�a Working Papers 0314, Banco de Espa�a.
  7. Fiorito, Riccardo & Kollintzas, Tryphon, 2002. "Public Goods, Merit Goods, and the Relation Between Private and Government Consumption," CEPR Discussion Papers 3617, C.E.P.R. Discussion Papers.
  8. 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.
  9. Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Optimal simple and implementable monetary and fiscal rules," Working Paper 2007-24, Federal Reserve Bank of Atlanta.
  10. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  11. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  12. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, sunspots, and automatic stabilizers," Working Paper Series, Macroeconomic Issues WP-96-16, Federal Reserve Bank of Chicago.
  13. Jordi Gali & J. David Lopez-Salido & Javier Valles, 2004. "Rule-of-Thumb Consumers and the Design of Interest Rate Rules," NBER Working Papers 10392, National Bureau of Economic Research, Inc.
  14. Guo, Jang-Ting & Harrison, Sharon G., 2006. "Government size and macroeconomic stability: A comment," European Economic Review, Elsevier, vol. 50(5), pages 1339-1346, July.
  15. Ni, Shawn, 1995. "An empirical analysis on the substitutability between private consumption and government purchases," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 593-605, December.
  16. N. Gregory Mankiw, 1999. "The Savers-Spenders Theory of Fiscal Policy," Harvard Institute of Economic Research Working Papers 1888, Harvard - Institute of Economic Research.
  17. Rochelle M. Edge & Jeremy B. Rudd, 2002. "Taxation and the Taylor principle," Finance and Economics Discussion Series 2002-51, Board of Governors of the Federal Reserve System (U.S.).
  18. Fatas, Antonio & Mihov, Ilian, 2001. "Government size and automatic stabilizers: international and intranational evidence," Journal of International Economics, Elsevier, vol. 55(1), pages 3-28, October.
  19. Carlstrom, Charles T. & Fuerst, Timothy S., 2005. "Investment and interest rate policy: a discrete time analysis," Journal of Economic Theory, Elsevier, vol. 123(1), pages 4-20, July.
  20. Stephanie Schmitt-Grohe & Martin Uribe, 1995. "Balanced-budget rules, distortionary taxes, and aggregate instability," Finance and Economics Discussion Series 95-44, Board of Governors of the Federal Reserve System (U.S.).
  21. repec:fth:harver:1435 is not listed on IDEAS
  22. Roisland, Oistein, 2003. "Capital income taxation, equilibrium determinacy, and the Taylor principle," Economics Letters, Elsevier, vol. 81(2), pages 147-153, November.
  23. Gali, Jordi, 1994. "Government size and macroeconomic stability," European Economic Review, Elsevier, vol. 38(1), pages 117-132, January.
  24. John Bailey Jones, 1999. "Has Fiscal Policy Helped Stabilize the Postwar U.S. Economy?," Discussion Papers 99-03, University at Albany, SUNY, Department of Economics.
  25. Evans, Paul & Karras, Georgios, 1998. "Liquidity Constraints and the Substitutability between Private and Government Consumption: The Role of Military and Non-military Spending," Economic Inquiry, Western Economic Association International, vol. 36(2), pages 203-14, April.
  26. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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