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Optimal Monetary and Fiscal Policy in a New Keynesian Model with a Dutch Disease: The Case of Complete Markets

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  • Constantino Hevia
  • Pablo Andrés Neumeyer
  • Juan Pablo Nicolini

Abstract

We analyze optimal policy in New Keynesian model of a small open economy with access to complete asset markets and Dutch Disease periods, in which terms of trade shocks reallocate resources away from the manufacturing sector. Following the policy debate, we introduce an externality in the manufacturing sector that makes the Dutch disease periods inefficient. We show theoretically that if the government has access to standard taxes that can be made time and state dependent, the optimal monetary policy implies complete price stability. The optimal intervention to deal with the externality in manufacturing is a subsidy. We next assume that taxes do not respond to temporary shocks and study monetary policy as the sole stabilization instrument. Using a calibrated version of the model we show that the externality and the lack of other policy instruments do not justify sizeable departures from price stability.

Suggested Citation

  • Constantino Hevia & Pablo Andrés Neumeyer & Juan Pablo Nicolini, 2013. "Optimal Monetary and Fiscal Policy in a New Keynesian Model with a Dutch Disease: The Case of Complete Markets," Department of Economics Working Papers 2013-3, Universidad Torcuato Di Tella.
    • Handle: RePEc:udt:wpecon:2013-3
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    Cited by:

    1. Constantino Hevia & Juan Pablo Nicolini, 2015. "Política Monetaria y la Enfermedad Holandesa: Rigidez de Precios y de Salarios," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 18(2), pages 28-60, August.
    2. Claudia De la Huerta & Javier Garcia-Cicco, 2016. "Commodity Prices, Growth and Productivity: a Sectoral View," Working Papers Central Bank of Chile 777, Central Bank of Chile.
    3. Constantino Hevia & Juan Pablo Nicolini, 2015. "Monetary Policy and Dutch Disease: The Case of Price and Wage Rigidity," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Caputo & Roberto Chang (ed.),Commodity Prices and Macroeconomic Policy, edition 1, volume 22, chapter 3, pages 051-089, Central Bank of Chile.
    4. Bergholt, Drago & Røisland, Øistein & Sveen, Tommy & Torvik, Ragnar, 2023. "Monetary policy when export revenues drop," Journal of International Money and Finance, Elsevier, vol. 137(C).
    5. Orrego, Fabrizio & Vega, Germán, 2013. "Dutch disease and fiscal policy," Working Papers 2013-021, Banco Central de Reserva del Perú.
    6. García-Cicco, Javier & Kawamura, Enrique, 2015. "Dealing with the Dutch disease: Fiscal rules and macro-prudential policies," Journal of International Money and Finance, Elsevier, vol. 55(C), pages 205-239.
    7. García-Cicco, Javier & Kawamura, Enrique, 2015. "Dealing with the Dutch disease: Fiscal rules and macro-prudential policies," Journal of International Money and Finance, Elsevier, vol. 55(C), pages 205-239.

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