RICERCA ITALIANA     

Monetary and Fiscal Stabilization policies, the exchange rate and the term structure of interest rates

Università Commerciale "Luigi Bocconi" - Milano

Abstract

The research program has two main objectives:
1) The analysis of the fiscal-monetary policy mix in the determination of macroeconomic outcomes
2) The analysis of the responses of asset prices, such as exchange rates and the term structure of interest rates to different identified shocks and systematic policies.
Our contribution will be both theoretical and empirical.
On the theory side we plan to extend the new-keynesian macroeconomic modelling approach to consider the impact of heterogeneous expectations and monetary and fiscal policy interactions in determining solution determinacy and E-stability conditions for the Rational Expectations Equilibrium
On the empirical side we shall estimate a New Keynesian model and use the estimated structural paramenters to investigate the design of optimal monetary and fiscal stabilization policies. Special attention will be devoted to the specification of fiscal policy rules.
Baseline models, which considers closed economy and no term structure of inteest rates, shall be then extended to evaluate the impact of policies on the exchange rates and on the term structure, with special attention for the term premia. The analyis of the term structure of interest rates will then give us the opportunity to introduce models of indexation for long-term bonds.
The research units in Bologna (Basevi with Marzo, Onofri and Lubik) and in Rome (Senesi with Mattesini and Scaramozzino) will mainly work >>>

Principal Investigator

Carlo Ambrogio FAVERO Università Commerciale "Luigi Bocconi" MILANO

Research Objectives

The research program has two main objectives:
1) The analysis of the fiscal-monetary policy mix in the determination of macroeconomic outcomes
2) The analysis of the responses of asset prices, such as exchange rates and the term structure of interest rates to different identified policies.
Our contribution will be both theoretical and empirical.In particular we propose to extend the vaste empirical literature on monetary policy rules to fiscal policy rules. We shall then include rules in a small macro model the evaluate the importance of the fiscal-monetary policy mix in the determination of macroeconomic outcomes. All models considered will be estimated (on data for the US and the Euro area) and simulated for policy evaluation. We shall also extend the baseline closed economy model with a single financial asset to consider explicitly the impact of the policy mix on the exchange rates and the term structure of interest rates.

First Results

Development of models viable to estimation, construction of databases relevant to the empirical applications, first empirical resultsModel utilization for policy analysis, production of working papers, submission to international journals.

Timescale

24 months

National and international background

Recently we have witnessed a vivid interest in macroeconomics for the analysis of policy regimes. Yet nearly the whole literature (both theoretical and empirical) has focused on monetary policy in complete isolation, and in particular from fiscal policy. The main justification for this bias lies in the theoretically well-rooted paradigm according to which inflation stabilization should be a concern of the monetary authority only. The more independent such authority, the more credible and therefore the more successful in achieving the primary goal of reducing and stabilizing inflation. This view is at the core of the so-called New Keynesian monetary policy literature, centered around the polar star of the Taylor principle. See the widely cited work of Woodford (2003) and Clarida, Gali and Gertler (1999).

This conventional view typically suffers of two shortcomings. First, it often overlooks that, as emphasized for instance by Leeper (1991), Woodford (1996, 2001), Benhabib, Schmitt-Grohe and Uribe (2002), an appropriately defined monetary policy rule requires also an appropriately defined fiscal policy rule. Existence and uniqueness of rational expectations equilibria, as well as macroeconomic outcomes, hinge crucially on the underlying specification of the monetary-fiscal mix. Second, it typically assumes stability in the underlying fiscal policy regime. The latter is usually represented as passive (in the sense of Leeper, 1991), namely either featuring a >>>