Fluctuating Macro Policies and the Fiscal Theory

51 Pages Posted: 26 Apr 2005 Last revised: 20 Feb 2022

See all articles by Troy Davig

Troy Davig

Federal Reserve Bank of Kansas City

Eric M. Leeper

University of Virginia ; Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER); George Mason University - Mercatus Center

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Date Written: March 2005

Abstract

This paper estimates regime-switching rules for monetary policy and tax policy over the post-war period in the United States and imposes the estimated policy process on a calibrated dynamic stochastic general equilibrium model with nominal rigidities. Decision rules are locally unique and produce a stationary long-run rational expectations equilibrium in which (lump-sum) tax shocks always affect output and inflation. Tax non-neutralities in the model arise solely through the mechanism articulated by the fiscal theory of the price level. The paper quantifies that mechanism and finds it to be important in U.S. data, reconciling a popular class of monetary models with the evidence that tax shocks have substantial impacts. Because long-run policy behavior determines existence and uniqueness of equilibrium, in a regime-switching environment more accurate qualitative inferences can be gleaned from full-sample information than by conditioning on policy regime.

Suggested Citation

Davig, Troy and Leeper, Eric Michael, Fluctuating Macro Policies and the Fiscal Theory (March 2005). NBER Working Paper No. w11212, Available at SSRN: https://ssrn.com/abstract=689393

Troy Davig

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Eric Michael Leeper (Contact Author)

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