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

Raffaele Rossi

Macroeconomic Dynamics, 2014, vol. 18, issue 2, 395-417

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.

Date: 2014
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Working Paper: Designing monetary and Fiscal policy rules in a New Keynesian model with rule-of-thumb consumers (2009)
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