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Optimal Monetary and Fiscal Stabilisation Policies

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  • Klaus Adam

    (University of Mannheim)

Abstract

This paper studies optimal stabilisation policies under commitment when monetary policy sets nominal interest rates and fiscal policy decides on public expenditure, income tax rates, and issuance of nominal non-contingent debt. High levels of government debt adversely affect the steady state of the economy and increase aggregate volatility. The latter emerges because debt exposes the government budget to real interest rate risk and thereby induces stronger volatility of taxes and public spending. The optimal variability of fiscal deficits is found to increase with the level of government debt, while the optimal variability of nominal interest rates decreases. Overall, optimal stabilisation policy does not require annual fiscal deficits to deviate by more than 3 percentage points of GDP from their steady state value or nominal interest rates to fall all the way to zero. Only if the standard deviation of economic disturbances is two to three times larger than suggested by post-war evidence do such events occur with non-negligible probability. Politique optimale de stabilisation monétaire et budgétaire Cet article étudie la politique optimale de stabilisation dans des conditions telles que la politique monétaire fixe les taux d’intérêt nominaux et la politique budgétaire détermine les dépenses publiques, les taux de l’impôt sur les revenus et l’émission de la dette nominale non contingente. Un niveau élevé d’endettement public a des effets négatifs sur l’état stationnaire de l’économie et accroît la volatilité globale. Cette volatilité tient à ce que la dette expose le budget de l’État à un risque de taux d’intérêt réel et provoque donc une plus grande instabilité de l’impôt et des dépenses publiques. On constate que la variabilité optimale des déficits budgétaires s’accroît en fonction du niveau de la dette publique, contrairement à la variabilité des taux d’intérêt nominaux, qui diminue. Au total, une politique optimale de stabilisation n’exige pas que le déficit budgétaire annuel s’écarte de plus de 3 points de PIB de sa valeur à l’état stationnaire, ni que les taux d’intérêt nominaux tombent totalement à zéro. C’est seulement si l’écart type des perturbations économiques est deux à trois fois supérieur aux résultats observés depuis la fin de la guerre que de tels événements se produisent, avec une probabilité non négligeable.

Suggested Citation

  • Klaus Adam, 2010. "Optimal Monetary and Fiscal Stabilisation Policies," OECD Economics Department Working Papers 765, OECD Publishing.
  • Handle: RePEc:oec:ecoaaa:765-en
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    File URL: http://dx.doi.org/10.1787/5kmfwj7s5pjk-en
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    References listed on IDEAS

    as
    1. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    2. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January.
    3. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
    4. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
    5. Adam, Klaus & Billi, Roberto M., 2008. "Monetary conservatism and fiscal policy," Journal of Monetary Economics, Elsevier, pages 1376-1388.
    6. 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.
    7. Javier Diaz-Gimenez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2008. "Nominal Debt as a Burden on Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 493-514, July.
    8. Luis J. Álvarez & Emmanuel Dhyne & Marco Hoeberichts & Claudia Kwapil & Hervé Le Bihan & Patrick Lünnemann & Fernando Martins & Roberto Sabbatini & Harald Stahl & Philip Vermeulen & Jouko Vilmunen, 2006. "Sticky Prices in the Euro Area: A Summary of New Micro-Evidence," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 575-584, 04-05.
    9. Ascari, Guido & Ropele, Tiziano, 2007. "Optimal monetary policy under low trend inflation," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2568-2583, November.
    10. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
    11. Adam, Klaus & Billi, Roberto M., 2014. "Distortionary fiscal policy and monetary policy goals," Economics Letters, Elsevier, pages 1-6.
    12. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, pages 586-606.
    13. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-417, June.
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    More about this item

    Keywords

    dette publique non contingente; distorsions fiscales; distortionary taxes; dépenses publiques; government spending; interest rate policy; non-contingent government debt; politique de taux d’intérêt; Politique optimale de Ramsey; Ramsey optimal policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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