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Government policy in monetary economies

  • Fernando M. Martin

I study how the general and specific details of a micro founded monetary framework affect the determination of policy when the government has limited commitment. The conduct of policy depends on the interaction between the incentive to smooth distortions intertemporally and a time-consistency problem. In equilibrium, fiscal and monetary policies are distortionary, but long-run policy is not afflicted by time-consistency problems. Policy variables in specific applications of the general framework react similarly to variations in fundamentals. Nevertheless, resolving certain environment frictions affect long-run policy significantly. The response of government policy to aggregate shocks is qualitatively similar across the studied model variants. However, there are significant quantitative differences in the response of government policy to productivity shocks, mainly due to the idiosyncratic behavior of the money demand. Environments with no trading frictions display the best fit to post-war U.S. data.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2011-026.

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Date of creation: 2011
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Handle: RePEc:fip:fedlwp:2011-026
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  17. Stefan Niemann, 2009. "Dynamic Monetary-Fiscal Interactions and the Role of Monetary Conservatism," Economics Discussion Papers 667, University of Essex, Department of Economics.
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  19. Fernando Martin, 2009. "On the Joint Determination of Fiscal and Monetary Policy," Discussion Papers dp09-01, Department of Economics, Simon Fraser University.
  20. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
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