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Can Fiscal Policy Help Macroeconomic Stabilisation? Evidence from a New Keynesian Model with Liquidity Constraints

  • Anton Muscatelli
  • Patrizio Tirelli
  • Carmine Trecroci

This paper derives a New Keynesian dynamic general equilibrium model with liquidity- constrained consumers and sticky prices. The model allows a role for both government spending and taxation in the DGE model. The model is then estimated using US data. We demonstrate that there seems to be a significant role for rule-of-thumb consumer behaviour. Our model is then used to analyse the interaction between fiscal and monetary policies. We examine the extent to which fiscal policy (automatic stabilisers) assist or hinder monetary policy when the latter takes a standard forward-looking inflation targeting form. We also examine the extent to which inertia in fiscal policy and the presence of rule-of-thumb consumers affects output and inflation variability in the presence of such a monetary policy rule.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1171.

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Date of creation: 2004
Date of revision:
Handle: RePEc:ces:ceswps:_1171
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  1. Muscatelli, V Anton & Tirelli, Patrizio & Trecroci, Carmine, 2002. "Does Institutional Change Really Matter? Inflation Targets, Central Bank Reform and Interest Rate Policy in the OECD Countries," Manchester School, University of Manchester, vol. 70(4), pages 487-527, Special I.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  4. Javier Andrés & Rafael Doménech, 2006. "Fiscal Rules and Macroeconomic Stability," Hacienda Pública Española, IEF, vol. 176(1), pages 9-41, April.
  5. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Optimal Fiscal and Monetary Policy Under Sticky Prices," NBER Working Papers 9220, National Bureau of Economic Research, Inc.
  6. Campbell Leith & Jim Malley, 2002. "Estimated General Equilibrium Models for the Evaluation of Monetary Policy in the US and Europe," CESifo Working Paper Series 699, CESifo Group Munich.
  7. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  8. Muscatelli, V. Anton & Tirelli, Patrizio & Trecroci, Carmine, 2004. "Fiscal and monetary policy interactions: Empirical evidence and optimal policy using a structural New-Keynesian model," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 257-280, June.
  9. Anton Muscatelli & Patrizio Tirelli & Carmine Trecroci, 2001. "Monetary and Fiscal Policy Interactions over the Cycle: Some Empirical Evidence," Working Papers 2002_13, Business School - Economics, University of Glasgow, revised Oct 2002.
  10. David B. Gordon & Eric M. Leeper, 2005. "Are Countercyclical Fiscal Policies Counterproductive?," NBER Working Papers 11869, National Bureau of Economic Research, Inc.
  11. Andrew Mountford & Harald Uhlig, 2009. "What are the effects of fiscal policy shocks?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(6), pages 960-992.
  12. Dixit, Avinash & Lambertini, Luisa, 2001. "Monetary-fiscal policy interactions and commitment versus discretion in a monetary union," European Economic Review, Elsevier, vol. 45(4-6), pages 977-987, May.
  13. Jones, John Bailey, 2002. "Has fiscal policy helped stabilize the postwar U.S. economy?," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 709-746, May.
  14. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers 200112, Rutgers University, Department of Economics.
  15. Paolo ZAGAGLIA, 2002. "On (Sub)Optimal Monetary Policy Rules under Untied Fiscal Hands," Working Papers 162, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
  16. John B. Taylor, 2000. "Reassessing Discretionary Fiscal Policy," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 21-36, Summer.
  17. Pérez, Javier J. & Hiebert, Paul, 2002. "Identifying endogenous fiscal policy rules for macroeconomic models," Working Paper Series 0156, European Central Bank.
  18. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  19. Christopher D Carroll, 2000. "Solving Consumption Models with Multiplicative Habits," Economics Working Paper Archive 421, The Johns Hopkins University,Department of Economics.
  20. Alex Cukierman & V. Anton Muscatelli, 2002. "Do Central Banks have Precautionary Demands for Expansions and for Price Stability? - Theory and Evidence," CESifo Working Paper Series 764, CESifo Group Munich.
  21. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  22. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, vol. 110(462), pages C93-108, March.
  23. repec:oup:qjecon:v:115:y:2000:i:1:p:147-180 is not listed on IDEAS
  24. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," NBER Working Papers 9420, National Bureau of Economic Research, Inc.
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