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Monetary and Fiscal Policy Switching

Hess Chung (), Troy Davig () and Eric Leeper ()

No 274, Econometric Society 2004 North American Summer Meetings from Econometric Society

Abstract: Interest rate rules for monetary policy and tax rules for fiscal policy change stochastically between two regimes. In the first regime monetary policy follows the Taylor principle and taxes rise strongly with increases in the real value of government debt; in the second regime the Taylor principle fails to hold and taxes follow an exogenous stochastic process. Because agents? decision rules embed the probability that policies will change qualitatively in the future, monetary and tax shocks always produce wealth effects, breaking down Ricardian Equivalence. The impacts of monetary policy shocks can also be different because their fiscal implications (and wealth effects) are different when regime can change. If monetary policy adjusts the interest rate at all in response to inflation, then i.i.d. policy shocks propagate for many periods. The paper also addresses two empirical issues. First the 'price puzzle' that plagues monetary VARs is a natural outcome of periods when monetary policy fails to obey the Taylor principle and taxes do not respond to the state of government indebtedness. Second, dynamic correlations between fiscal surpluses and government liabilities, which have been interpreted as consistent with Ricardian Equivalence, can be produced by an underlying equilibrium that is non-Ricardian

Keywords: Monetary-Fiscal Interactions; Regime-Switching (search for similar items in EconPapers)
JEL-codes: E32 E40 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Related works:
Journal Article: Monetary and Fiscal Policy Switching (2007)
Journal Article: Monetary and Fiscal Policy Switching (2007) Downloads
Working Paper: Monetary and fiscal policy switching (2005) Downloads
Working Paper: Monetary and Fiscal Policy Switching (2004) Downloads
Working Paper: Monetary and Fiscal Policy Switching (2004) Downloads
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