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Monetary Concequences of Alternative Fiscal Policy Rules

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  • Jukka Railavo

    () (Monetary Policy and Research Department Bank of Finland)

Abstract

In this paper we analyse the monetary impact of alternative fiscal policy rules using the debt and deficit, both mentioned as measures of fiscal policy performance in the Stability and Growth Pact (SGP). We use a New Keynesian model, with distortionary taxation and an appropriately defined output gap. The economy is hit by two fundamental shocks: demand and supply shocks, which are orthogonal to each other. Monetary policy is conducted by an independent central bank that will optimise. Under discretionary monetary policy the size of the inflation bias depends on the fiscal policy regime. Using the timeless perspective approach to precommitment, output persistence increases compared to the discretionary case. The result holds with the alternative fiscal policy rules, and inflation and output persistence reflects the economic data. With the deficit rules, the autocorrelation of the tax rate is near unity irrespective of the monetary policy regime, and irrespective of the fiscal policy parameters and targets. Thus we revive Barro's (1979) random walk result with the deficit rules

Suggested Citation

  • Jukka Railavo, 2005. "Monetary Concequences of Alternative Fiscal Policy Rules," Computing in Economics and Finance 2005 145, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:145
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    References listed on IDEAS

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    More about this item

    Keywords

    Inflation; monetary policy; fiscal policy; policy coordination;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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