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Optimal Fiscal Stabilisation through Government Spending

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  • Fabian Eser

    () (Nuffield College, Oxford University, Oxford.)

Abstract

This paper examines under what conditions fiscal policy in the form of government spending should contribute to macroeconomic stabilisation. To this end optimal fiscal targeting rules minimising the microfounded social loss are examined in the following settings. Firstly, for the benchmark New Keynesian model, where monetary policy is unconstrained, a neutrality result for fiscal obtains: fiscal policy should not respond to any shocks. Secondly, if monetary policy is constrained to follow a Taylor rule, a stabilisation role for fiscal policy emerges. Fiscal policy should 'lean against' inflation and be countercyclical relative to output. Crucially, the Taylor principle is shown to remain the key requirement on policy to guarantee equilibrium determinacy. Thirdly, the fiscal targeting rule obtained under a Taylor rule is shown to be optimal, too, when policy is optimal but subject to monetary frictions. Thus, there is a stabilisation role for government spending under monetary frictions, changing the role of monetary and fiscal policy fundamentally.

Suggested Citation

  • Fabian Eser, 2009. "Optimal Fiscal Stabilisation through Government Spending," Economics Papers 2009-W14, Economics Group, Nuffield College, University of Oxford.
  • Handle: RePEc:nuf:econwp:0914
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    File URL: http://www.nuffield.ox.ac.uk/economics/papers/2009/w14/091008_FEser_FiscalStabilisation.pdf
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    References listed on IDEAS

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    Cited by:

    1. Simon Wren-Lewis & Fabian Eser, 2009. "When is Monetary Policy All we Need?," Economics Series Working Papers 430, University of Oxford, Department of Economics.
    2. Paulo Vieira & Celsa Machado & Ana Paula Ribeiro, 2016. "Optimal Fiscal Simple Rules for Small and Large Countries of a Monetary Union," EcoMod2016 9685, EcoMod.

    More about this item

    Keywords

    Monetary Policy; Fiscal Policy; Macroeconomic Stabilisation; Discretion; Dynamic General Equilibrium; Sticky Prices; Monetary Frictions; Equilibrium Determinacy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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