When is monetary policy all we need?

Fabian Eser, Campbell Leith and Simon Wren-Lewis

Working Papers from Business School - Economics, University of Glasgow

Abstract: We consider optimal monetary and fiscal policies in a New Keynesian model of a small open economy with sticky prices and wages. In this benchmark setting monetary policy is all we need - analytical results demonstrate that variations in government spending should play no role in the stabilization of shocks. In extensions we show, firstly, that this is even when true when allowing for inflation inertia through backward-looking rule-of-thumb price and wage-setting, as long as there is no discrepancy between the private and social evaluation of the marginal rate of substitution between consumption and leisure. Secondly, the optimal neutrality of government spending is robust to the issuance of public debt. In the presence of debt government spending will deviate from the optimal steady-state but only to the extent required to cover the deficit, not to provide any additional macroeconomic stabilization. However, unlike government spending variations in tax rates can play a complementary role to monetary policy, as they change relative prices rather than demand.

Keywords: Monetary Policy; Fiscal Policy; Macroeconomic Stabilization; Dynamic General Equilibrium; Sticky Prices; Sticky wages; Rule-of-Thumb Behaviour; Debt; Countercyclical Policy (search for similar items in EconPapers)
JEL-codes: C62 E5 E6 (search for similar items in EconPapers)
Date: 2009-05
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (23)

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Related works:
Working Paper: When is Monetary Policy All we Need? (2009)
Working Paper: When is Monetary Policy All we Need? (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2009_18

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