Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time

Bernd Hayo and Britta Niehof
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Britta Niehof: University of Marburg

MAGKS Papers on Economics from Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung)

Abstract: To analyse the interdependence between monetary and fiscal policy during a financial crisis, we develop an open-economy DSGE model with monetary and fiscal policy as well as financial markets in a continuous-time framework based on stochastic differential equations. Monetary policy is modelled using both a standard and a modified Taylor rule and fiscal policy is modelled as either expansionary or austere. In addition, we differentiate between open economies and monetary union members. We find evidence that the modified Taylor rule notably reduces the likelihood that the financial market crisis affects the real economy. But if we assume that households are averse with respect to outstanding government debt, we find that a combination of expansionary monetary policy and austere fiscal policy provides better stabilisation of both domestic and foreign economies in terms of both output and inflation. In the case of a monetary union, we find that stabilisation of output in the country where the financial shock originates is no longer as easy and, in terms of prices, there is now deflation in the country where the crisis originated and a positive inflation rate in the other country.

Keywords: New Keynesian Models; Financial Crisis; Dynamic Stochastic General Equilibrium Models; Continuous Time Model; Fiscal Policy; Monetary Policy (search for similar items in EconPapers)
JEL-codes: C63 E44 E47 E52 E62 F41 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
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Journal Article: Monetary and Fiscal Policy in Times of Crisis: A New Keynesian Perspective in Continuous Time (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:mar:magkse:201455

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