Euro Area Monetary and Fiscal Policy Tracking Design in the Time-Frequency Domain

47 Pages Posted: 20 Aug 2015

See all articles by Patrick M. Crowley

Patrick M. Crowley

Texas A&M University - Corpus Christi; Bank of Finland/Suomen Pankki

David Hudgins

Texas A&M-Corpus Christi-College of Business

Date Written: August 12, 2015

Abstract

​This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995-2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.

Keywords: Discrete Wavelet Analysis, Euro area, Fiscal Policy, LQ Tracking, Monetary Policy, Optimal Control

JEL Classification: C49, C61, C63, C88, E52, E61

Suggested Citation

Crowley, Patrick M. and Hudgins, David, Euro Area Monetary and Fiscal Policy Tracking Design in the Time-Frequency Domain (August 12, 2015). Bank of Finland Research Discussion Paper No. 12/2015, Available at SSRN: https://ssrn.com/abstract=2647281 or http://dx.doi.org/10.2139/ssrn.2647281

Patrick M. Crowley (Contact Author)

Texas A&M University - Corpus Christi ( email )

6300 Ocean Drive, Unit #5808
Corpus Christi, TX 78412
United States

HOME PAGE: http://patrickmcrowley.com

Bank of Finland/Suomen Pankki ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

David Hudgins

Texas A&M-Corpus Christi-College of Business ( email )

6300 Ocean Drive, Unit #5808
Corpus Christi, TX 78412
United States

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