When is Monetary Policy All we Need?

Campbell Leith and Simon Wren-Lewis

No 2009-25, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

Abstract: We consider optimal monetary and scal 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, rstly, that this is even when true when allowing for in ation 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: Behaviour; Sticky Prices; Sticky wages; Monetary Policy; Fiscal Policy; Macroeconomic Stabilization; Dynamic General Equilibrium; Rule-of-Thumb; Debt; Countercyclical Policy (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (22)

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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:edn:sirdps:111

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