Government Policy in Monetary Economies
37 Pages Posted: 13 Apr 2012
Date Written: January 24, 2012
Abstract
I study how the general and specific details of a micro founded monetary framework affect the determination of policy when the government has limited commitment. The conduct of policy depends on the interaction between the incentive to smooth distortions intertemporally and a time-consistency problem. In equilibrium, fiscal and monetary policies are distortionary, but long-run policy is not aicted by time-consistency problems. Policy variables in specific applications of the general framework react similarly to variations in fundamentals. Nevertheless, resolving certain environment frictions affect long-run policy significantly. The response of government policy to aggregate shocks is qualitatively similar across the studied model variants. However, there are significant quantitative differences in the response of government policy to productivity shocks, mainly due to the idiosyncratic behavior of the money demand. Environments with no trading frictions display the best fit to post-war U.S. data.
Keywords: government policy, limited commitment, Markov-perfect equilibrium, financial intermediation, trading frictions, micro founded models of money
JEL Classification: E13, E52, E62, E63
Suggested Citation: Suggested Citation