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Investment Spending,Equilibrium Indeterminacy and the Interactions of Monetary and Fiscal Policy

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  • Thomas Lubik

Abstract

This paper investigates determinacy of equilibrium in a canonical New Keynesian model under different monetary and fiscal policy rules. It is shown that a simple monetary rule that responds aggressively to inflation is a necessary condition for equilibrium determinacy, when fiscal policy is accommodating. If there is a high degree of structural distortions in the economy, then the interesting possibility arises that both aggressive monetary and fiscal policies are required to guarantee existence. When investment adjustment costs are introduced, the monetary and fiscal policy dichotomy is in principle maintained. The determinacy region is, however, highly dependent on the degree of distortion in the economy. The more prices are sticky, and the less competitive firms are, the economy is likely to exhibit indeterminacy even if monetary policy is active.

Suggested Citation

  • Thomas Lubik, 2003. "Investment Spending,Equilibrium Indeterminacy and the Interactions of Monetary and Fiscal Policy," Economics Working Paper Archive 490, The Johns Hopkins University,Department of Economics.
    • Handle: RePEc:jhu:papers:490
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    File URL: http://www.econ2.jhu.edu/REPEC/papers/WP490_lubik.pdf
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    References listed on IDEAS

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    1. Lubik, Thomas A. & Marzo, Massimiliano, 2007. "An inventory of simple monetary policy rules in a New Keynesian macroeconomic model," International Review of Economics & Finance, Elsevier, vol. 16(1), pages 15-36.
    2. Stephanie Schmitt-Grohe & Jess Benhabib & Martin Uribe, 2001. "Monetary Policy and Multiple Equilibria," American Economic Review, American Economic Association, vol. 91(1), pages 167-186, March.
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    6. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
    7. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
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    12. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Papers (Old Series) 0009, Federal Reserve Bank of Cleveland.
    13. Thomas,Alex M., 2021. "Macroeconomics," Cambridge Books, Cambridge University Press, number 9781108731997.
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    Cited by:

    1. Marco Ratto, 2008. "Analysing DSGE Models with Global Sensitivity Analysis," Computational Economics, Springer;Society for Computational Economics, vol. 31(2), pages 115-139, March.
    2. Lubik, Thomas A. & Marzo, Massimiliano, 2007. "An inventory of simple monetary policy rules in a New Keynesian macroeconomic model," International Review of Economics & Finance, Elsevier, vol. 16(1), pages 15-36.
    3. Tommy Sveen & Lutz Weinke, 2004. "Firm-Specific Investment, Sticky Prices, and the Taylor Principle," Working Paper 2004/12, Norges Bank.
    4. Kremer, Jana, 2004. "Fiscal rules and monetary policy in a dynamic stochastic general equilibrium model," Discussion Paper Series 1: Economic Studies 2004,35, Deutsche Bundesbank.
    5. Chen, Shu-Hua, 2015. "Macroeconomic (In)Stability Of Interest Rate Rules In A Model With Banking System And Reserve Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 19(7), pages 1476-1508, October.
    6. Seiya Fujisaki & Kazuo Mino, 2008. "Income Taxation, Interest-Rate Control and Macroeconomic Stability with Balanced-Budget," Discussion Papers in Economics and Business 08-20, Osaka University, Graduate School of Economics.

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