Government deficits, wealth effects and the price level in an optimizing model

Barbara Annicchiarico ()

No 285, Working Paper Series from European Central Bank

Abstract: This paper investigates the inflationary effects of fiscal policy in an optimising general equilibrium monetary model with capital accumulation, flexible prices and wealth effects. The model is calibrated to Euro Area quarterly data. Simulation results show that government deficits, high debt level and slow fiscal adjustment adversely affect price stability in the presence of an independent monetary authority adopting a monetary targeting regime. The mechanism through which fiscal policy affects the dynamics of the price level presents monetarist properties, since the price level is determined in the monetary market. The effects produced by fiscal expansions on price dynamics are due to the behaviour of consumers, sharing the burden of fiscal adjustment with future generations. Fiscal variables are shown to influence the consumption plan of individuals and the demand for real money balances, thus affecting the equilibrium conditions in the money market where the price level is determined. JEL Classification: E31; E62.

Keywords: Price stability; fiscal policy and Government debt. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec, nep-mac and nep-pbe
Date: 2003-11
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