A fiscal stimulus with deep habits and optimal monetary policy

Abstract

A New-Keynesian model with deep habits and optimal monetary policy delivers a fiscal multiplier above one and the crowding-in effect on private consumption obtainable in a Real Business Cycle model à la Ravn et al. (2006). Optimized Taylor-type or price-level interest rate rules yield results close to optimal policy and dominate a conventional Taylor interest rate rule. Private consumption is crowded out only if the Taylor rule is sub-optimal and then negates the fiscal stimulus by responding strongly to the output gap, or if the ability to commit is absent. At the zero lower bound private consumption is always crowded in across simple rules.JEL classification: E30, E62.

Optimal Fiscal and Monetary Policy, Debt Crisis, and Management

“…As in Cantore et al (2012) "optimality" can mean the welfare-optimal (Ramsey) policy, or timeconsistent policy or optimised Taylor-type interest rate and fiscal rules. 12 Fiscal rules use (16) for the taxation instrument τ t and (17) for government spending G t .…”

“…5 In the context of a NK model, Cantore et al (2012) compare simple interest-rate rules embedding the model-based definition of the output gap to rules employing deviations of output from the steady state. They find that when the two types of rule are designed to be optimal, they result in almost identical real and inflation outcomes.…”

Optimal Fiscal and Monetary Policy, Debt Crisis and Management

“…a composite of differentiated habit-adjusted private, (X c t ) j , and public consumption goods, G t , respectively, similar to that in Bouakez and Rebei (2007), Pappa (2009) and Cantore et al (2012), which allows for (X t ) j = (X c t ) j as a special case and allows both for complementarity and substitutability between the two types of goods, as explained in Section 2.6.…”

Economic Openness and Fiscal Multipliers

“…We follow Cantore et al (2012) and do not distinguish between habit formation of the government and the households, that is we set θ c = θ g = θ = θ. This implies that in equilibrium ν c = ν g = ν and c = g = .…”

“…Both Cantore, Levine, Melina & Yang (2012) and Zubairy (2014) develop New Keynesian models with deep-habit formation. The former test its implication for optimal monetary policy and the latter study equilibrium determinacy under different interest rate rules.…”