Analyzing the Interaction of Monetary and Fiscal Policy: Does Fiscal Policy Play a Valuable Role in Stabilisation?

This paper provides an overview of recent papers which use estimated New Keynesian models to study the extent to which fiscal policy can beused to stabilize the economy. We use a varietyof different New Keynesian models, estimated on data for both theUS and for theEuro area, and highlight the diverse transmission channelst hrough which fiscal policy acts in these models. Although we find that fiscal policy can provide a useful complement to monetary policy, especially in models where consumers have finite horizons, there are import limitations to the value added of fiscal policy

Do Central Banks have Precautionary Demands for Expansions and for Price Stability? - Theory and Evidence

This paper analyses the impact of asymmetric preferences with respect to inflation and output by policymakers on interest-rate reaction functions and test for their existence. A modified New Keynesian framework which makes it possible to identify the dominant type of asymmetry is developed and related to the precautionary demand of policymakers for expansions and for low inflation. Using data for four G7 economies, the paper shows that, except for Germany, nonlinear and asymmetric behaviour is present. A main finding, for the US, is that after credibility-building and disinflation have been established, the monetary authority develops a greater precautionary demand for output expansions than for low inflation. This may generate a new type of inflation bias. Conversely, where, as is the case in the UK, credibility-building is still a concern for the authorities, managing the business cycle is dominated by concerns of the monetary authorities to keep inflation expectations low.

Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints

This paper derives a New Keynesian dynamic general equilibrium model with liquidity constrained consumers and sticky prices. The model allows a role for both government spending and taxation in the DGE model. The model is then estimated using Euro area data. We demonstrate that there seems to be a significant role for rule-of-thumb consumer behaviour. Our model is then used to analyse the interaction between fiscal and monetary policies. We examine the extent to which fiscal policy (automatic stabilisers) assist or hinder monetary policy when the latter takes a standard forward-looking inflation targeting form. We also examine the extent to which inertia in fiscal policy and the presence of rule-of-thumb consumers affects output and inflation variability in the presence of such a monetary policy rule.

Fiscal and Monetary policy Interactions in a New Keynesian Model with Liquidity Constraints

This paper derives a NewKeynesiandynamic general equilibrium model with liquidity constrained consumers and sticky prices. The model allows a role for both government spending and taxation in the DGE model. The mode lis then estimated using US data. We demonstrate that there seems to be a significant role for rule-of-thumb consumer behaviour. Our model is then used to analyse the interaction between Fiscal and monetary policies. We examine the extent to which fiscal policy (automatic stabilisers) assist or hinder monetary policy when the latter takes a standard forward-looking inflation targetingf orm. We also examine the extent to which inertia in fiscal policy and the presence of rule-of-thumb consumers aspects output and inflation variability in the presence of such a monetary policy rule..

FISCAL CONSOLIDATION AND DECENTRALISATION: A TALE OF TWO TIERS

This paper contributes to the established literature on fiscal consolidations (e.g. Alesina and Perotti, 1995, 1997, Alesina et al, 1998) by investigating the distinct behaviour of central and sub-central tiers of government during general government consolidation attempts. In the light of different degrees of decentralisation across OECD countries, and the different responsibilities devolved to sub-central tiers, we believe that this approach offers an illuminating insight into the analysis of fiscal consolidations and their success. We show that the involvement of the sub-central tiers of government is crucial to achieving cuts in expenditure, particularly in relation to the overall size of the government wage bill. In addition, central governments appear to exert a strong influence on the expenditure of subcentral tiers through their grant allocations, and control of these allocations appears to have a considerable impact upon the overall success of consolidation attempts. Finally we demonstrate that there is a skewness in cuts towards sub-central capital expenditure both when central governments cut grant allocations and when sub-central governments engage in lone consolidation attempts.

Fiscal Federalism and Fiscal Consolidation: Evidence from an Event Study

Fiscal consolidations, episodes where governments make large discretionary improvements in their fiscal positions, have received considerable attention, especially in EMU. The existing literature demonstrates that the composition of consolidations is a crucial determinant of their success. We show that sub-central governments also play a key role in consolidations through sustained cuts in expenditures, as their intergovernmental grants are cut. In contrast to existing studies we find that cuts in capital spending at sub-central levels are a feature of successful consolidations. We also show that the government type and the nature of fiscal arrangements in a country impact on these results.

Real Business Cycles of Sticky Prices? The Impact of Technology Shocks on US Manufacturing

No abstract.

Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints

This paper derives a New Keynesian dynamic general equilibrium model with liquidity constrained consumers and sticky prices. The model allows a role for both government spending and taxation in the DGE model. The model is then estimated using US data. We demonstrate that there seems to be a significant role for rule-of-thumb consumer behaviour. Our model is then used to analyse the interaction between fiscal and monetary policies. We examine the extent to which fiscal policy (automatic stabilisers) assist or hinder monetary policy when the latter takes a standard forward-looking inflation targeting form. We also examine the extent to which inertia in fiscal policy and the presence of rule-of-thumb consumers affects output and inflation variability in the presence of such a monetary policy rule.

A simple and flexible alternative to the Stability and Growth Pact deficit ceilings. Is it at hand?

We use a simple theoretical model of a monetary union where myopic discretionary fiscal policies generate excessive debt accumulation in steady state and inefficiently delayed debt adjustment following a shock. We advocate the adoption of a flexible debt targeting approach. By setting a long-term debt target and by raising the political cost associated to deviations from the optimal pace of debt reversal following a shock¸ institutional design induces the fiscal policymaker to implement unbiased discretionary responses to shocks. Since the power to discipline fiscal policymakers rests in the hands of national voters, this outcome can be achieved by increasing the transparency of the decision-making process, where national voters understand the long-term consequences of fiscal policies. In practice, we call for clearer and more focused supervision tasks for the European Commission and for a more active role of national Parliaments whenever a disagreement arises between the Commission and a national government.