Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints

We survey the possible costs of the unconventional monetary policy measures undertaken by major central banks after the outbreak of the global financial crisis in 2008. We argue that these costs are not easily discernable in the new Keynesian (NK) model, which defines a theoretical framework for monetary policy. First, the costs may result from the effects of unconventional monetary policy measures on the intensity of restructuring and the persistence of uncertainty (which increased after the outbreak of the crisis). However, neither of these processes is considered in the new Keynesian model. Second, costs may be generated not only by distortions in the choices made by economic agents but may also be a result of the decisions made by governments, particularly in terms of the fiscal deficit level. However, the new Keynesian model does not consider the effects of unconventional monetary policy measures on the quality of fiscal policy. Without carefully considering the costs, there is a significant risk that unconventional monetary policy measures could become a conventional response to recurrent crises.

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Monetary Policy in the New Keynesian Model

Kieler Studien - Kiel Studies - Monetary Policy and the German Unemployment Problem in Macroeconomic Models ◽

10.1007/3-540-37679-8_4 ◽

2007 ◽

pp. 114-170

Keyword(s):

Monetary Policy ◽

New Keynesian ◽

New Keynesian Model ◽

Keynesian Model

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Optimal fiscal and monetary policy under different fiscal instruments

Journal of Economic Studies ◽

10.1108/jes-11-2019-0508 ◽

2020 ◽

Vol 48 (1) ◽

pp. 167-190

Author(s):

Mehrab Kiarsi

Keyword(s):

Monetary Policy ◽

Inflation Rate ◽

Dynamic Properties ◽

Sticky Prices ◽

New Keynesian ◽

Content Type ◽

Friedman Rule ◽

Keynesian Model ◽

Fiscal And Monetary Policy ◽

Cash In Advance

PurposeThe paper includes characterizing Ramsey policy in a cash-in-advance monetary model, under flexible and sticky prices, and with different fiscal instruments.Design/methodology/approachThe paper analytically and numerically characterizes the dynamic properties of Ramsey allocations. The author computes dynamics by solving second-order approximations to the Ramsey planner’s policy functions around a non-stochastic Ramsey steady state.FindingsThe Friedman rule is not mainly optimal in a cash-in-advance model with distorting taxes. The Ramsey-optimal policy with both taxes on income and consumption calls for a high inflation rate that is extremely volatile, despite the fact that changing prices is costly.Practical implicationsThe optimality of zero nominal interest rate under flexible prices in monetary models is not mainly the case and quite depends on the preferences. The optimality of a zero inflation rate under sticky prices also very much depends on the assumed set of fiscal instruments.Originality/valueThe non-optimality of the Friedman rule under flexible prices is quite new. Moreover, studying the optimal fiscal and monetary policy in a New Keynesian model with a rich set of fiscal instruments is also quite original.

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