Monetary–fiscal policy interactions and fiscal stimulus

Increases in government spending trigger substitution effects—both inter- and intra-temporal—and a wealth effect. The ultimate impacts on the economy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes create a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between active and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model's predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act's implied path for government spending under alternative monetary–fiscal policy combinations.     

Inflation dynamics and the cost channel of monetary transmission

Evidence from vector autoregressions indicates that the impact of interest rate shocks on macroeconomic aggregates can substantially be affected by the so-called cost channel of monetary transmission. In this paper, we apply a structural approach to examine the relevance of the cost channel for inflation dynamics in G7 countries. Since firms’ costs of working capital increase with interest rates, we augment a (hybrid) New Keynesian Phillips curve by including the short-run nominal interest rate. We find significant and varying direct interest rate effects for the majority of countries, including member countries of the EMU. Simulations further demonstrate that the estimated interest rate coefficients can substantially affect inflation responses to monetary policy shocks, and can even lead to inverse inflation responses, when the cost channel is - relative to the demand channel - sufficiently strong.     

FiMod — A DSGE model for fiscal policy simulations

This paper develops a medium-scale dynamic, stochastic, general equilibrium (DSGE) model for fiscal policy simulations. Relative to existing models of this type, our model incorporates two important features. First, we consider a two-country monetary union structure, which makes it well suited to simulate fiscal measures by relatively large countries in a currency area. Second, we provide a notable degree of disaggregation on the government expenditures side, by explicitly distinguishing between (productivity-enhancing) public investment, public purchases and the public sector wage bill. In addition, we consider a labor market characterized by search and matching frictions, which allows to analyze the response of equilibrium unemployment to fiscal measures. In order to illustrate some of its applications, and motivated by recent policy debate in the Euro Area, we calibrate the model to Spain and the rest of the area and simulate a number of fiscal consolidation scenarios. We find that, in terms of output and employment losses, fiscal consolidation is the least damaging when achieved by reducing the public sector wage bill, whereas it is most damaging when carried out by cutting public investment.     

The role of labor markets for euro area monetary policy

In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions. We first investigate to which extent a more flexible labor market would alter the business cycle behavior and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.     

Fiscal policy and private consumption in industrial and developing countries

This paper empirically studies the effects of fiscal policy shocks on private consumption. Further, it investigates if the initial financing needs of the government or previous fiscal deficits affect that relationship. We use yearly data between 1970 and 2000 for 40 countries, of which 19 are industrialized and 21 are developing countries. In general, the estimation results seem to indicate that government consumption shocks have Keynesian effects for both industrial and developing countries. In the case of tax shocks, the evidence is mixed. Furthermore, there is no evidence that favors the hypothesis of expansionary fiscal consolidations.     

Government debt,inflation dynamics and the transmission of fiscal policy shocks

We analyze the influence of the fiscal position on the transmission of government spending shocks in a New Keynesian model. We find that once we allow for positive levels of government debt in the steady state, the size of the fiscal multiplier depends strongly on the horizon at which the multiplier is evaluated. While the long-run effect of a fiscal policy innovation is typically of a similar order of magnitude as in Galí et al. (2007), short-run multipliers differ substantially. The reason for this non-monotonic behavior is the interaction between the dynamics of the inflation rate and the debt level in real terms for sufficiently high levels of government debt in the steady state.     

Liquidity traps, learning and stagnation

We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.     

Spillover effects of fiscal policy in a monetary union: Why do fiscal instruments matter?

Using a two‐country DSGE model, we analyse the spillover effects of fiscal policy in a monetary union. Based on a non‐Walrasian labour market with a labour force participation decision and involuntary unemployment and a detailed fiscal sector, we focus on the relative cross‐border effects of different kinds of fiscal shocks (government expenditure and tax shocks). Among the major lessons from this analysis, five general and striking results are worth highlighting : (1) spillover effects differ widely according to the fiscal instrument, (2) all fiscal instruments produce positive spillover effects on foreign GDP except a rise in government consumption, (3) the response of unemployment is not always negatively correlated with the response of output (4) the different fiscal shocks trigger different effects on foreign inflation and the term of trade, which implies heterogeneous interest‐rate and trade channels, and (5) a more accommodative monetary policy and a scenario of ‘fiscal dominance’ alter greatly the effects of fiscal policy shocks.     

Overturning Mundell: Fiscal Policy in a Monetary Union

Central to ongoing debates over the desirability of monetary unions is a supposed trade-off, outlined by Mundell (1961) : a monetary union reduces transactions costs but renders stabilization policy less effective. If shocks across countries are sufficiently correlated, then, according to this argument, delegating monetary policy to a single central bank is not very costly and a monetary union is desirable.
This paper explores this argument in a setting with both monetary and fiscal policies. In an economy with monetary policy alone, we confirm the presence of the trade-off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low. However, fiscal interventions by national governments, combined with a central bank that has the ability to commit to monetary policy, overturn these results. In equilibrium, such a monetary union will be welfare improving for any correlation of shocks.     

Poole in the New Keynesian model

We study the properties of alternative central bank targeting procedures within the standard New Keynesian model. We find that Poole's famous insights concerning the output stabilization properties of money and interest rate targeting obtain when intertemporal substitution is low. And that output volatility rankings do not induce similar welfare rankings. Unlike the popular presumption, money targeting always fares better for money demand shocks. For fiscal shocks, money targeting does better for low and worse for high degree of intertemporal substitution. The opposite pattern obtains for supply shocks.     

ON FISCAL MULTIPLIERS: ESTIMATES FROM A MEDIUM SCALE DSGE MODEL

This article contributes to the debate on fiscal multipliers, in the context of an estimated dynamic stochastic general equilibrium model, featuring a rich fiscal policy block and a transmission mechanism for government spending shocks. I find the multiplier for government spending to be 1.07, which is largest on impact. The multipliers for labor and capital tax on impact are 0.13 and 0.34, respectively. The effects of tax cuts take time to build and exceed stimulative effects of spending by 12–20 quarters. I carry out counterfactual exercises to show how alternative financing methods and expected monetary policy have consequences for the size of fiscal multipliers.     

Optimal monetary policy in a New Keynesian model with endogenous growth

We study optimal monetary policy in a New Keynesian (NK) model with endogenous growth and knowledge spillovers external to each firm. We find that, in contrast with the standard NK model, the Ramsey dynamics implies deviation from full inflation targeting in response to technology and government spending shocks, while the optimal operational rule is backward looking and responds to inflation and output deviations from their long-run levels.     

Monetary and fiscal policy transmission in Poland

This paper combines a fiscal structural vector-autoregression (SVAR) with a monetary SVAR for the Polish transition economy. Data are constructed from scratch in order to account for features of the transition economy and for delays in implementing legislated government spending and tax changes (fiscal foresight). For monetary policy, we find no price puzzles in the combined SVAR. Also, fiscal foresight variables have no statistically significant effects. We calculate an initial government spending multiplier of 0.70, which later peaks at 1.61 for the cumulative multiplier. This multiplier is much larger than multipliers estimated in previous studies not combining fiscal and monetary policy, where they were found to be close to zero. On the other hand, the tax multiplier is generally near zero in our study. We demonstrate the importance of combining fiscal and monetary transmission mechanisms when assessing the effects of government macroeconomic policies.     

Data uncertainty and the role of money as an information variable for monetary policy

In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.     

Monetary and fiscal policy interactions: Evidence from emerging European economies

This paper examines the interactions between fiscal and monetary policy for some former transition, emerging European economies over the 1995Q1–2010Q4 period by using a Markov regime-switching model. We consider the monetary policy rule proposed by Taylor (1993) and the fiscal policy rule suggested by Davig and Leeper (2007) in accounting for monetary and fiscal policy interactions. Empirical results suggest that monetary and fiscal policy rules exhibit switching properties between active and passive regimes and all countries followed both active and passive monetary policies. As for fiscal policy, the Czech Republic, Estonia, Hungary, and Slovenia seem to have alternated between active and passive fiscal regimes while fiscal policies of Poland and the Slovak Republic can be characterized by a single fiscal regime. Although the policy mix and the interactions between monetary and fiscal policy point a diverse picture in our sample countries, the monetary policy seems to be passive in all countries after 2000. This finding is consistent with the constraints imposed by European Union enlargement on monetary policy.     

Effects of government spending shocks in China,Japan, and Korea

ABSTRACT

This study investigates the effects of government spending shocks on various key macro variables in China, Korea, and Japan using structural VAR models. The main empirical findings are as follows. Government spending multipliers of all three countries are far larger than 1 in recent years. The effectiveness of fiscal expansion has not changed markedly in China but substantially increased in Korea (after the Asian financial crisis) and Japan (during zero lower bound period). Increases in the effectiveness of fiscal expansion are associated with changes in the monetary and exchange rate policy regimes and institutions of these countries. Among the three countries, the government spending multiplier is relatively large in China but relatively small in Japan in recent years. Although the effects on exchange rate and trade balance vary across countries and sample periods, real exchange rate tends to depreciate, whereas trade balance tends to improve under flexible exchange rate regimes. Some empirical findings are consistent with standard theory, but others are not.

Abbreviations: NK: New Keynesian VAR: Vector Autoregressive ZLB: Zero Lower Bound     

Macroeconomic transitions and the transmission mechanism: Evidence from Turkey

This paper investigates changes to the macroeconomic transmission mechanism in Turkey following a major reform of monetary policy in the early 2000s. We use a Threshold VAR (TVAR) framework to test for and then estimate a model with endogenous transitions between regimes. We detect two regimes, with a clear transition between them in 2003–4. The pre-reform regime is characterized by high inflation, passive monetary policy and persistent responses to shocks. The post-reform regime is characterized by low inflation, active and credible monetary policy and markedly less persistent responses to shocks. Using a model that contains sufficient variables to capture diverse transmission mechanisms, working through the real exchange rate, domestic credit and monetary policy, we find evidence of sharp changes in transmission mechanisms. Post-reform, the response of Turkey to macroeconomic shocks has changed to be similar to those in other modern, market-orientated economies.     

Optimal monetary policy in a Phillips-curve world

In this paper, we study optimal monetary policy in a model that integrates the modern theory of unemployment with a liquidity model of monetary transmission. Two policy environments are considered: period-by-period optimization (time consistency) and full commitment (Ramsey allocation). When the economy is subject to productivity shocks, the optimal policy is pro-cyclical. We also characterize the long-term properties of monetary policy and show that with commitment the optimal inflation rate is inversely related to the bargaining power of workers. Both results find empirical support in the data.     

Effects of monetary and government spending policy on economic inequality

Using detailed micro-level income and expenditure data, we study the effects of monetary and government spending policy shocks on income and expenditure inequality in the US from 1990 to 2018. We find that expansionary monetary and government spending policy shocks systematically decrease income, disposable income and expenditure inequality. There is evidence of time variation on the effects and monetary policy and transfer payment shocks. Various impulse responses suggest that the impacts of the policy shocks increase during and after the Great Recession. The responses of income and expenditures of households at different percentiles suggest that expansionary monetary and government spending policy have a larger positive impact on households with low income and expenditures relative to those at the top of the distribution. We do not find evidence of the significant impact of Quantitative Easing policies on income inequality, however, expenditure inequality appear to increase due to the policies.