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

Research output: Contribution to journalJournal article

Published
<mark>Journal publication date</mark>03/2014
<mark>Journal</mark>Macroeconomic Dynamics
Issue number2
Volume18
Number of pages23
Pages (from-to)395-417
Publication statusPublished
Early online date13/06/12
Original languageEnglish

Abstract

This 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.

Bibliographic note

http://journals.cambridge.org/action/displayJournal?jid=MDY The final, definitive version of this article has been published in the Journal, Macroeconomic Dynamics, 18 (2), pp 395-417 2014, © 2014 Cambridge University Press.