CEF.UP – ECO Seminar

Tuesday – March 18^th, 2025, at 1:00 p.m. | Room 305| Online

Brothers in Arms: Near Equivalence of Monetary and Fiscal Rules

Lukasz Rachel  –  University College London (England, United Kingdom)

Abstract:

“We consider monetary-fiscal interaction in a New Keynesian model with finite planning horizons. We argue that the introduction of finite planning horizons has fundamental implications for the impact of monetary and fiscal policy rules and for the impact of aggregate shocks. There are three main findings. First, the determinacy properties are dramatically different in our model, relative to the standard setting: bounded equilibria might cease to exist when the central bank follows the Taylor principle and the fiscal policy does not stabilize government debt sufficiently. Second, the sharp difference in equilibrium outcomes depending on the precise parameters of the policy rules that is present in the textbook model largely disappears — indeed, the properties of the equilibria vary smoothly with policy rule parameters. Third, and different to the textbook model, anticipation of shocks plays a major role: an expansionary deficit-news shock can lead a recession accompanied with higher inflation and heightened macroeconomic volatility.”