Research Discussion Papers, Bank of Finland
No 20/2004:
Monetary consequences of alternative fiscal policy rules
Jukka Railavo ()
Abstract: In this paper we analyse the monetary impact of
alternative fiscal policy rules using the debt and deficit, both mentioned
as measures of fiscal policy performance in the Stability and Growth Pact
(SGP). We use a New Keynesian model, with endogenous labour supply,
distortionary taxation and no private capital. The economy is hit by two
fundamental shocks: demand and supply shocks, which are orthogonal to each
other. Monetary policy is conducted by an independent central bank that
will optimise. Under discretionary monetary policy the size of the
inflation bias depends on the fiscal policy regime. Using the timeless
perspetive approach to precommitment, output persistence increase compared
to the discretionary case. The result holds with the alternative fiscal
policy rules, and inflation and output persistence reflects the economic
data. With the deficit rules, the autocorrelation of the tax rate is near
unity irrespective of the monetary policy regime, and irrespective of the
fiscal policy parameters and targets.
Keywords: inflation; optimal monetary policy; fiscal policy; policy coordination; (follow links to similar papers)
JEL-Codes: E31; E52; E61; E62; (follow links to similar papers)
33 pages, October 13, 2004
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