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DESIGNING MONETARY AND FISCAL POLICY RULES IN A NEW KEYNESIAN MODEL WITH RULE-OF-THUMB CONSUMERS

Published online by Cambridge University Press:  13 June 2012

Raffaele Rossi
Raffaele Rossi*
Affiliation:
University of Milano-Bicocca
*
Address correspondence for Raffaele Rossi, Department of Economics, University of Milano-Bicocca, Piazza dell'Ateneo Nuovo 1, 20126 Milan, Italy; e-mail: [email protected].
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Abstract

This paper studies the determinacy properties of monetary and fiscal policy rules in a small-scale New Keynesian model. We modify the standard model in two ways. First, we allow positive public debt in the steady state as in Leeper [Journal of Monetary Economics 27, 129–147 (1991)]. Second, we add rule-of-thumb consumers as in Bilbiie [Journal of Economic Theory 140, 162–196 (2008)]. Leeper studied a model in which Ricardian equivalence holds, and he showed that monetary and fiscal policy can be studied independently. In Bilbiie's analysis, rule-of-thumb consumers break the Ricardian equivalence and generate important consequences for the design of monetary policy. In his model, steady-state public debt was equal to zero. We study a model with both rule-of-thumb consumers and positive steady-state public debt. We find that the mix of fiscal and monetary policies that guarantees equilibrium determinacy is sensitive to the exact values of the parameters of the model.

Keywords

Rule-of-thumb consumersRicardian equivalencePublic debtMonetary–fiscal policy interactions
Type
Articles
Information
Macroeconomic Dynamics , Volume 18 , Issue 2 , March 2014 , pp. 395 - 417
Copyright
Copyright © Cambridge University Press 2012 

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