Research program
Monetary and Fiscal Stabilization policies, the exchange rate and the term structure of interest rates
University Co-ordinator
Università Commerciale "Luigi Bocconi" MILANO -
ECONOMIA POLITICA - MILANO(MI)
Research Unit Leader
Carlo Ambrogio FAVERO
Description
In the work on Monetary-Fiscal Mix and Macroeconomic Outcomes we have three main goals:1) We aim at transfering onto fiscal policy the same logical apparatus of the regime-based approach recently used in the empirical analysis of monetary policy. Accordingly we investigate if a rule-based systematic representation can well track the behavior of fiscal policy after 1960 in the U.S. With this respect our view contrasts with the one of a recent literature that tries to quantify the effects of the unanticipated component of fiscal policy on a series of key macroeconomic variables (Blanchard and Perotti (2001), Perotti (2002), Burnside, Eichenbaum and Fisher (2002)). 2) We wish to understand whether a monetary-fiscal mix, better than a monetary policy regime only, has contributed to shape the postwar inflation-output dynamics in the U.S.. 3) We aim at exploring how the presence of breaks in the fiscal policy regime might have interacted with the existing monetary policy regime in shaping the U.S. output-inflation dynamics. We improve on existing contributions in the literature in two ways. First, we allow for a more general specification of the fiscal rule. In principle we maintain that fiscal policy may respond to two complementary goals. On the one hand, the government may display some concern for long-run fiscal solvency and therefore for the evolution of the government debt (the "passive"component). However, fiscal policy may also be employed for business cycle stabilization purposes (the "active" component). Hence we specify a fiscal rule in which the primary deficit is allowed to respond (non-linearly) to the level of the existing debt and (linearly) to the output gap. Secondly, we allow the fiscal regime to vary over time, and employ Markov-switching regression methods to identify such regime changes endogenously.Simultaneously we plan to extend the existing conditional investigation of the term structure fluctuations by assessing the response of long-term rates to different shocks. In practice we shall consider heterogeneity between monetary and fiscal shocks and between policy and preference shocks. Finally, in order to account for the discrepancies between the predictions of RBC models on the effect of fiscal policy and the empirical evidence we plan we plan to modify the neoclassical approach in two dimensions. First, we will introduce agents with finite life (see Blanchard, 1985). First, we will introduce agents with finite life (see Blanchard, 1985). Agents with finite horizon have a discount rate which exceeds the rate at which government can borrow. In this case individuals do not fully capitalize the future tax burden associated with government expenditure and, as a consequence, there is no complete crowding out of private consumption by government expenditure. Second, we will introduce monopolistic competition and nominal price rigidities. This will allow us to model an additional channel through which government expenditure can affect private consumption. With nominal price rigidities, increases in aggregate demand, such as those that are caused by increases in government spending, will raise output together with labor demand and real wages. This increase in labor income will tend to raise consumption, thus counteracting the negative impact of the wealth effect.Carlo Favero and Tommaso Monacelli will work on the relation between monetary and fiscal mix and macroeconomic equilibrium. Ulf Soderstrom and Carlo Favero will work on the conditional analysis of the term structure responses to different shocks. Antonella Trigari e Luca Sala will mainly concentrate on the macoreconomic impact of fiscal shocks.
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