Global Determinacy Under Monetary and Fiscal Policy Switchings
45 Pages Posted: 12 Oct 2016 Last revised: 21 Oct 2016
Date Written: October 21, 2016
This paper examines equilibrium determinacy in the context of a structural regime switching macro model with monetary and fiscal policy switching. We first show theoretically and in practice that the long-run Taylor principle proposed by Davig and Leeper (2007) is necessary but not sufficient for determinacy in mean-square stability sense. We then show that stochastic switching in policy stances substantially changes the determinacy region. On the one hand, a unique stable equilibrium under regime switching may exist when monetary and fiscal policies are both recurrently passive or active. On the other hand, a switch between two alternative policy combinations which imply determinacy under two fixed-regimes often requires a large swing in fiscal policy in order to achieve global determinacy, ruling out some traditionally determinate equilibria. Finally, we show that money growth management can be an alternative to active fiscal policy in a zero lower-bound scenario in order to lead the economy to global determinacy.
Keywords: Markov Switching, Macro Model, Interest Rate Monetary Policy Rule, Fiscal Policy, Macroeconomic Stability, Policy Instruments
JEL Classification: C62, D84, E31, E32, E42, E52, E58, E62, E63
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