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Optimal Fiscal Stabilisation through Government Spending

  • Fabian Eser

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.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2009-W14.

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Date of creation: 01 Nov 2009
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Handle: RePEc:oxf:wpaper:2009-w14
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