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Optimal Fiscal and Monetary Rules in Normal and Abnormal Times

Author

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  • Cantore, C. M.
  • Levine, P.
  • Melina, G.
  • Pearlman, J.

Abstract

We examine fiscal-monetary interactions in a New-Keynesian model with deep habits, distortionary taxes and a sovereign risk premium for government debt. Deep habits crucially affect the fiscal transmission mechanism in that these lead to a counter-cyclical mark-up, boosting the size of a demand-driven output expansion with important consequences for monetary and fiscal policy. We employ Bayesian estimates of the model to compute optimal monetary and fiscal policy first in `normal times' with debt starting at its steady state and then in a crisis period with a much higher initial debt-GDP ratio. Policy is conducted in terms of optimal commitment, time consistent and simple Taylor-type rules. Welfare calculations and impulse responses indicate that the ability of the simple rules to closely mimic the Ramsey optimal policy, observed in the literature with optimal monetary policy alone, is still a feature of optimal policy with fiscal instruments, but only with `passive' fiscal policy. For crisis management we find some support for slow consolidation with a more active role for tax increases rather than a decrease in government spending.

Suggested Citation

  • Cantore, C. M. & Levine, P. & Melina, G. & Pearlman, J., 2013. "Optimal Fiscal and Monetary Rules in Normal and Abnormal Times," Working Papers 13/16, Department of Economics, City University London.
  • Handle: RePEc:cty:dpaper:13/16
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    File URL: http://openaccess.city.ac.uk/16758/1/13_16_Joe-and-Giovanni.pdf
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    References listed on IDEAS

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    1. Fr Chette, Guillaume R. & Kagel, John H. & Lehrer, Steven F., 2003. "Bargaining in Legislatures: An Experimental Investigation of Open versus Closed Amendment Rules," American Political Science Review, Cambridge University Press, vol. 97(02), pages 221-232, May.
    2. Battaglini, Marco & Nunnari, Salvatore & Palfrey, Thomas R., 2012. "Legislative Bargaining and the Dynamics of Public Investment," American Political Science Review, Cambridge University Press, vol. 106(02), pages 407-429, May.
    3. Jackson, Matthew O. & Moselle, Boaz, 2002. "Coalition and Party Formation in a Legislative Voting Game," Journal of Economic Theory, Elsevier, vol. 103(1), pages 49-87, March.
    4. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
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    1. repec:eee:gamebe:v:107:y:2018:i:c:p:60-92 is not listed on IDEAS
    2. repec:spr:jesaex:v:3:y:2017:i:1:d:10.1007_s40881-017-0038-x is not listed on IDEAS
    3. Miller, Luis & Montero, Maria & Vanberg, Christoph, 2018. "Legislative bargaining with heterogeneous disagreement values: Theory and experiments," Games and Economic Behavior, Elsevier, vol. 107(C), pages 60-92.
    4. Christiansen, Nels, 2015. "Greasing the wheels: Pork and public goods contributions in a legislative bargaining experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 120(C), pages 64-79.
    5. Cesar Martinelli & Thomas R. Palfrey, 2017. "Communication and Information in Games of Collective Decision: A Survey of Experimental Results," Working Papers 1065, George Mason University, Interdisciplinary Center for Economic Science.
    6. Agranov, Marina & Fr├ęchette, Guillaume & Palfrey, Thomas & Vespa, Emanuel, 2016. "Static and dynamic underinvestment: An experimental investigation," Journal of Public Economics, Elsevier, vol. 143(C), pages 125-141.
    7. Vespa, Emanuel I., 2016. "Malapportionment and multilateral bargaining: An experiment," Journal of Public Economics, Elsevier, vol. 133(C), pages 64-74.

    More about this item

    Keywords

    optimal fiscal and monetary rules; fiscal consolidation; deep habits;

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • H41 - Public Economics - - Publicly Provided Goods - - - Public Goods

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