Research Discussion Papers, Bank of Finland
No 34/2003:
Effects of the supply-side channel on stabilisation properties of policy rules
Jukka Railavo ()
Abstract: In this paper we introduce an application of the
supply-side channel for fiscal policy to the basic New Keynesian model. We
use a proportional tax rate instead of lump sum tax and introduce the
distortions of a tax wedge. We derive a closed economy forward-looking
model with government consumption and no capital. Households’ labour supply
decisions are endogenised. Monetary policy is conducted by a Taylor-type
interest rate rule and fiscal policy follows a simple debt rule. We analyse
the stability of the model when fiscal policy has both demand and
supply-side effects and compare results with the standard case of only
demand effects. We show that taking supply-side effects into account
restricts the fiscal policy parameter range consistent with the dynamic
stability of the economy. We also argue that allowing fiscal policy to
affect both supply and demand results in more persistent inflation as well
as output responses to shocks, than without the supply-side channel. We
also discuss the different monetary and fiscal policy regimes and their
implication on the stability of inflation and output.
Keywords: inflation; fiscal and monetary policy; stabilisation; (follow links to similar papers)
JEL-Codes: E31; E52; E63; (follow links to similar papers)
49 pages, October 16, 2003
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