Budgetary policies in a DSGE model with finite horizons

Abstract

This paper presents a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite horizons. Our New Keynesian framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. When calibrated to euro area quarterly data, the model predicts that fiscal expansions generate a trade-off in output dynamics between short-term gains and medium-term losses. It is shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization.JEL Classification: E52; E58; E63.

Essays on dynamic macroeconomics and optimal monetary policy

“…(2006) investigated the channels through which fiscal policy affects the main macrovariables, such as output and inflation, and the interactions between alternative fiscal and monetary policy regimes. In a similar spirit, Annicchiarico et al (2011) searched the macroeconomic consequences of fiscal policy in the same environment, where a government and a monetary authority apply fiscal and monetary policy that take the form of operational rules. Lately, Leith et al (2011) turned to normative aspects of fiscal policy by searching the optimal dynamics of the public debt in the OLG NK environment.…”

“…Indeed, within this framework, fiscal policy effects are closely associated with the nature of monetary policy. The interactions between fiscal and monetary policy rules constitutes the main research subject of Leith and Wren-Lewis (2000), Chadha and Nolan (2007), Annicchiarico et al (2008), Leith and von Thadden (2008), Annicchiarico et al (2011) and Ascari and Rankin (2010). In the OLG version of the NK model, the stability of the price level becomes closely associated with the nature of 2 First, Drazen (1981) employed the two-period overlapping generations modelá la Diamond-Samuelson to test the Sidrauski effect of money super-neutrality.…”

“…Insofar as the probability of death determines the sensitivity of aggregate consumption spending to non-human wealth, i.e., the departure from the Ricardian equivalence, I conduct a sensitivity analysis by using the values calibrated by the perpetual youth studies. For example, in quarterly frequency, Smets and Wouters (2002) and Annicchiarico et al (2011) set the probability of death equal to 0.01 and 0.015, respectively. According to Devereux (2011), the upper bound of the probability is equal to 0.05, or 0.2 annually, which implies a 5 year horizon for consumers' decision making.…”

“…While in the perpetual youth version of the NK model there is extensive research on the positive implications of fiscal expansion (Andrés et al 2006, Annicchiarico et al 2011, the interactions between monetary and fiscal policy, and the determinacy properties of fiscal and monetary policy rules as well 1 , there is almost no attention on the consequences of this kind of modeling specification on monetary policy aspects per se. Researchers take advantaged of this non Ricardian framework to examine the aforementioned issues, as money seignorage and government debt exercise a direct influence on aggregate demand due to the collapse of the Ricardian equivalence.…”

“…See for exampleLeith and Wren-Lewis (2000),Chadha and Nolan (2007),Annicchiarico et al (2008),Leith and von Thadden (2008),Annicchiarico et al (2011) andAscari and Rankin (2010) …”