Budgetary Policies in a DSGE Model with Finite Horizons

Annicchiarico, Barbara and Giammarioli, Nicola and Piergallini, Alessandro (2009): Budgetary Policies in a DSGE Model with Finite Horizons.

Abstract

This paper presents a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite horizons. Our New Keynesian framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. When calibrated to euro area quarterly data, the model predicts that fiscal expansions generate a trade-off in output dynamics between short-term gains and medium-term losses. It is shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal Policy; Monetary Policy; Nominal Rigidities; Capital Accumulation; Finite Lifetime; Simulations
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D58 - Computable and Other Applied General Equilibrium Models; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy

References

Annicchiarico, B. and A. Piergallini (2006), Monetary Rules and Deficit Shocks. Spanish Economic Review 9, 39-57.

Annicchiarico, B., Marini, G. and A. Piergallini (2008), Monetary Policy and Fiscal Rules. The B.E. Journal of Macroeconomics (Contributions) 8(1), Article 4.

Ascari, G. and N. Rankin (2007), Perpetual Youth and Endogenous Labour Supply: A Problem and a Possible Solution. Journal of Macroeconomics 29, 708-723.

Ascari, G. and N. Rankin (2007), Taylor Rules Cause Fiscal Policy Ineffectiveness. CDMA Conference Paper Series, No. 0707.

Benigno, G. and P. Benigno (2006), Designing Targeting Rules for International Monetary Cooperation. Journal of Monetary Economics 53, 473-506.

Bullard, J. and K. Mitra (2002), Learning about Monetary Policy Rules. Journal of Monetary Economics 49, 1105-1129.

Blanchard, O. J. (1985), Debt, Deficits, and Finite Horizons. Journal of Political Economy 93, 223-247.

Blanchard, O. J. and R. Perotti (2002), An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output. Quarterly Journal of Economics 117, 1329-1368.

Brock, W. A. (1975), A Simple Perfect Foresight Monetary Model. Journal of Monetary Economics 1, 133-150.

Calvo, G.A. (1983), Staggered Prices in a Utility Maximizing Framework. Journal of Monetary Economics 12, 383-398.

Clarida, R., Galí, J. and M. Gertler (1998), Monetary Policy Rules in Practice: Some International Evidence. European Economic Review 42, 1033-1067.

Clarida, R., Galí, J. and M. Gertler (1999), The Science of Monetary Policy: A New Keynesian Perspective. Journal of Economic Literature 37, 1661-1707.

Clarida, R., Galí, J. and M. Gertler (2000), Monetary Rules and Macroeconomic Stability: Evidence and Some Theory. Quarterly Journal of Economics 15, 147-180.

Fagan, G., Henry, J. and R. Mestre (2005), An Area-Wide Model (AWM) for the Euro Area. Economic Modelling 22, 39-59.

Favero, C. and T. Monacelli (2003), Monetary-Fiscal Mix and Inflation Performance: Evidence from the U.S. IGIER -- Università Bocconi, Working Paper 234.

Favero, C. and T. Monacelli (2005), Fiscal Policy Rules and Regime (In)Stability: Evidence from the U.S. IGIER -- Università Bocconi, Working Paper 282.

Frenkel, J. A. and A. Razin (1986), Fiscal Policies in the World Economy. Journal of Political Economy 94, 564-594.

Galí, J. (2008), Monetary Policy, Inflation and the Business Cycle. Princeton University Press.

Galí, J. and M. Gertler (2007), Macroeconomic Modeling for Monetary Policy Evaluation. Journal of Economic Perspectives 21, 25-45.

Galí, J., Gertler, M. and J.D. Lopéz-Salido (2001), European Inflation Dynamics. European Economic Review 45, 1237-1270.

Galí, J., López-Salido, D. and J. D. Vallés (2004), Rule-of-Thumb Consumers and the Design of Interest Rate Rules. Journal of Money, Credit, and Banking 36, 739-764.

Galí, J., López-Salido, D. and J.D. Vallés (2007), Understanding the Effects of Government Spending on Consumption. Journal of the European Economic Association 5, 227-270.

Galí, J. and R. Perotti (2003), Fiscal Policy and Macroeconomic Integration in Europe. Economic Policy 37, 533-572.

Gerlach, S. and G. Schnabel (2000), The Taylor Rule and Interest Rates in the EMU Area. Economics Letters 67, 165-171.

Goodfriend, M. and R.G. King (1997), The New Classical Synthesis and the Role of Monetary Policy. NBER Macroeconomic Annual 12, 231-283.

Judd, L.P. and G.D. Rudebusch (1998), Taylor's Rule and the Fed: 1970-1997. Federal Reserve Bank of San Francisco Economic Review 3, 3-16.

Klein, P. (2000), Using the Generalized Schur Form to Solve a Multivariate Linear Rational Expectations Model. Journal of Economic Dynamics & Control 24, 1405-1423.

King, R. and M. Watson (1996), Money, Prices, Interest Rates and the Business Cycle. Review of Economics and Statistics 78, 35-53.

Leeper, E. (1991), Equilibria under `Active' and `Passive' Monetary and Fiscal Policies. Journal of Monetary Economics 27, 129-147.

Leith, C. and S. Wren-Lewis (2000), Interactions between Monetary and Fiscal Policy Rules. The Economic Journal 110, C93-C108.

Leith, C. and L. von Thadden (2008), Monetary and Fiscal Policy Interactions in a New Keynesian Model with Capital Accumulation and Non-Ricardian Consumers. Journal of Economic Theory 140, 279-313.

Marini, G. and F. Van der Ploeg (1988), Monetary and Fiscal Policy in an Optimizing Model with Capital Accumulation and Finite Lives. The Economic Journal 98, 772-786.

McCallum, B.T. (2001), Should Monetary Policy Respond Strongly to Output Gaps? American Economic Review Papers and Proceedings 91, 258-262.

McCallum, B.T. (2003), Multiple-Solution Indeterminacies in Monetary Policy Analysis. Journal of Monetary Economics 50, 1153-1175.

McCallum, B.T. and E. Nelson (1999a), Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model, in J.B. Taylor (ed.), Monetary Policy Rules, Chicago and London: The University of Chicago Press, 15-56.

McCallum, B.T. and E. Nelson (1999b), An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis. Journal of Money, Credit and Banking 31, 296-316.

Mountford, A. and H. Uhlig (2008), What Are the Effects of Fiscal Policy Shocks? NBER Working Paper No. 14551.

Orphanides, A. (2001), Monetary Policy Rules Based on Real-Time Data. American Economic Review 91, 964-985.

Orphanides, A. (2003), Historical Monetary Policy Analysis and the Taylor Rule. Journal of Monetary Economics 50, 983-1022.

Perotti, R. (2002), Estimating the Effects of Fiscal Policy in OECD Countries. ECB Working Paper Series 168.

Piergallini, A. (2006), Real Balance Effects and Monetary Policy. Economic Inquiry 44, 497-511.

Rotemberg, J. and M. Woodford (1997), An Optimizing-Based Econometric Framework for the Evaluation of Monetary Policy, in Bernanke, B., Rotemberg J. (eds), NBER Macroeconomic Annual, Cambridge MA: The MIT Press, 297-346.

Rotemberg, J. and M. Woodford (1999), Interest Rate Rules in an Estimated Sticky Price Model, in J.B. Taylor (ed.), Monetary Policy Rules, Chicago and London: The University of Chicago Press, 57-119.

Sauer, S. and J.E. Sturm (2007), Using Taylor Rules to Understand ECB Monetary Policy. German Economic Review 8, 375-398.

Schmitt-Grohé, S. and M. Uribe (2000), Price Level Determinacy and Monetary Policy under a Balanced-Budget Requirement. Journal of Monetary Economics 45, 211-246.

Schmitt-Grohé, S. and M. Uribe (2004), Optimal Simple and Implementable Monetary and Fiscal Rules. Journal of Monetary Economics 54, 1702-1725.

Sidrauski, M. (1967), Rational Choice and Patterns of Growth in a Monetary Economy, American Economic Review 57, 534-544.

Sims, C.A. (1988), Identifying Policy Effects, in: Bryant, R.C. et al., Empirical Macroeconomics for Interdependent Economies, The Brookings Institutions, Washington, D.C, 305-321.

Smets, F. and R. Wouters (2002), Openness, Imperfect Exchange Rate Pass-Through and Monetary Policy. Journal of Monetary Economics 49, 947-981.

Smets, F. and R. Wouters (2003), An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area. Journal of European Economic Association 1, 1123-1175.

Taylor, J.B. (1993), Discretion Versus Policy Rules in Practice. Carnegie-Rochester Conference Series on Public Policy 39, 195-214.

Taylor, J. B. (1999a), Monetary Policy Rules. Chicago: The University of Chicago Press.

Taylor, J. B. (1999b), A Historical Analysis of Monetary Policy Rules, in J.B. Taylor (ed.), Monetary Policy Rules, Chicago: University of Chicago Press, 319-347.

Taylor, J.B. (2000a), The Policy Rule Mix: A Macroeconomic Policy Evaluation, in Guillermo Calvo, Rudi Dornbusch, and Maurice Obstfeld (eds.) Money, Capital Mobility and Trade, Essays in Honor of Robert Mundell, MIT Press, 505-518.

Taylor, J.B. (2000b), Reassessing Discretionary Fiscal Policy. Journal of Economic Perspectives 14, 21-36.

Woodford, M. (2001), The Taylor Rule and Optimal Monetary Policy. American Economic Review 91, 232-237.

Woodford, M. (2003), Interest and Prices. Princeton and Oxford: Princeton University Press.

Yaari, M.E. (1965), Uncertain Lifetime, Life Insurance, and the Theory of the Consumer. The Review of Economic Studies 32, 137-150.