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Debt Stabilisation Bias And The Taylor Principle: Optimal Policy In A New Keynesian Model With Government Debt And Inflation Persistence

  • Svan Jari Stehn

    ()

  • David Vines

    ()

Registered author(s):

    Leith and Wren-Lewis (2007) have shown that government debt is returned to its pre-shock level in a New Keynesian model under optimal discretionary policy. This has two important implications for monetary and fiscal policy. First, in a high-debt economy, it may be optimal for discretionary monetary policy to cut the interest rate in response to a cost-push shock - thereby violating the Taylor principle - although this will not be true if inflation is significantly persistent. Second, the optimal fiscal response to such a shock is more active under discretion than commitment, whatever the degree of inflation persistence.

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    File URL: http://cbe.anu.edu.au/research/papers/camawpapers/Papers/2007/Stehn_Vines_222007.pdf
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    Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2007-22.

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    Length: 35 pages
    Date of creation: Oct 2007
    Date of revision:
    Handle: RePEc:een:camaaa:2007-22
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    1. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
    2. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    4. Simon Wren-Lewis & Tatiana Kirsanova, 2007. "Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities," Economics Series Working Papers 306, University of Oxford, Department of Economics.
    5. Jordi Gali & David López-Salido & Javier Valles, 2004. "Understanding the effects of government spending on consumption," International Finance Discussion Papers 805, Board of Governors of the Federal Reserve System (U.S.).
    6. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609, November.
    7. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    8. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    9. Troy Davig & Eric M. Leeper, 2006. "Generalizing the Taylor Principle," Caepr Working Papers 2006-001, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    10. Garima Vasishtha & Taimur Baig & Manmohan S. Kumar & Edda Zoli, 2006. "Fiscal and Monetary Nexus in Emerging Market Economies; How Does Debt Matter?," IMF Working Papers 06/184, International Monetary Fund.
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    12. Leith, Campbell & Wren-Lewis, Simon, 2012. "Fiscal Sustainability in a New Keynesian Model," SIRE Discussion Papers 2012-84, Scottish Institute for Research in Economics (SIRE).
    13. Yash P. Mehra, 2004. "The output gap, expected future inflation and inflation dynamics: another look," Working Paper 04-06, Federal Reserve Bank of Richmond.
    14. Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Optimal simple and implementable monetary and fiscal rules," FRB Atlanta Working Paper 2007-24, Federal Reserve Bank of Atlanta.
    15. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    16. Srobona Mitra, 2007. "Is the Quantity of Government Debt a Constraint for Monetary Policy?," IMF Working Papers 07/62, International Monetary Fund.
    17. Pierpaolo Benigno & Michael Woodford, 2006. "Optimal Inflation Targeting Under Alternative Fiscal Regimes," Working Papers Central Bank of Chile 407, Central Bank of Chile.
    18. Christopher Allsopp & David Vines, 2005. "The Macroeconomic Role of Fiscal Policy," Oxford Review of Economic Policy, Oxford University Press, vol. 21(4), pages 485-508, Winter.
    19. Mehra Yash P, 2004. "The Output Gap, Expected Future Inflation and Inflation Dynamics: Another Look," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-19, December.
    20. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
    21. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
    22. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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