Designing monetary and fiscal policy rules in a new Keynesian model with rule-of-thumb consumers

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Abstract

his paper studies the determinacy properties of monetary and fiscal policy rules in a small-scale New Keynesian model. We modify the standard model in two ways. First, we allow positive public debt in the steady state as in Leeper [Journal of Monetary Economics 27, 129-147 (1991)]. Second, we add rule-of-thumb consumers as in Bilbiie [Journal of Economic Theory 140, 162-196 (2008)]. Leeper studied a model in which Ricardian equivalence holds, and he showed that monetary and fiscal policy can be studied independently. In Bilbiie's analysis, rule-of-thumb consumers break the Ricardian equivalence and generate important consequences for the design of monetary policy. In his model, steady-state public debt was equal to zero. We study a model with both rule-of-thumb consumers and positive steady-state public debt. We find that the mix of fiscal and monetary policies that guarantees equilibrium determinacy is sensitive to the exact values of the parameters of the model.
Original languageEnglish
JournalMacroeconomic Dynamics
DOIs
Publication statusPublished - 1 Mar 2014

Keywords

  • Monetary-fiscal policy interactions; Public debt; Ricardian equivalence; Rule-of-thumb consumers

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