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Our Research Catalogue contains grants and outputs data up until April/May 2014.

New Directions in Monetary and Fiscal Policy Analysis at the Macroeconomic Level

Grant reference: RES-062-23-1436

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Journal article details

Fiscal sustainabilitry in a new Keynesian model
Recent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady-state debt to follow a random walk. In this paper we consider the nature of the time-inconsistency involved in such a policy and its implication for discretionary policy-making. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady-state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government’s objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt-stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi-commitment policy which allows for different probabilities of reneging on past promises
English

Primary contributor

Co-author Campbell Leith

Additional contributors

Co-author Simon Wren-Lewis

Additional details

Yes
0022-2879
Blackwell Publishing
01 January 2013
Oxford
Pre-print
Journal of money, credit and banking

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