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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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File URL: http://www.nuff.ox.ac.uk/economics/papers/2009/w14/091008_FEser_FiscalStabilisation.pdf
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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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  1. George W. Evans & Eran Guse & Seppo Honkapohja, 2007. "Liquidity Traps, Learning and Stagnation," University of Oregon Economics Department Working Papers 2007-9, University of Oregon Economics Department, revised 05 Jun 2007.
  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. Tatiana Kirsanova & David Vines & Mathan Satchi & Simon Wren-Lewis, 2005. "Optimal Fiscal Policy Rules in a Monetary Union," Money Macro and Finance (MMF) Research Group Conference 2005 40, Money Macro and Finance Research Group.
  4. Fabian Eser & Campbell Leith & Simon Wren-Lewis, 2009. "When is monetary policy all we need?," Working Papers 2009_18, Business School - Economics, University of Glasgow.
  5. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2009. "Monetary and Fiscal Policy Interaction: The Current Consensus Assignment in the Light of Recent Developments," Economic Journal, Royal Economic Society, vol. 119(541), pages F482-F496, November.
  6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  7. S. Gnocchi, 2007. "Discretionary Fiscal Policy and Optimal Monetary Policy in a Currency Area," Working Papers 602, Dipartimento Scienze Economiche, Universita' di Bologna.
  8. Simon Wren-Lewis & Fabian Eser, 2009. "When is Monetary Policy All we Need?," Economics Series Working Papers 430, University of Oxford, Department of Economics.
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