When is Monetary Policy All we Need?

Simon Wren-Lewis and Fabian Eser

No 430, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We consider optimal monetary and fiscal 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, firstly, that this is even true when allowing for inflation inertia through backward-looking rule-of-thumb price and wage-setting, as long as there in 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: Monetary policy; Fiscal policy; Macroeconomic stabilization; Dynamic general equilibrium; Sticky prices; Sticky wages; Rule-of-thumb; Behaviour; Debt; Countercyclical policy (search for similar items in EconPapers)
JEL-codes: C62 E5 E6 (search for similar items in EconPapers)
Date: 2009-05-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: Add references at CitEc
Citations: View citations in EconPapers (22)

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Related works:
Working Paper: When is Monetary Policy All we Need? (2009)
Working Paper: When is monetary policy all we need? (2009)
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