Fiscal Policy Effectiveness and Neutrality Results in a Non-Ricardian World
30 Pages Posted: 2 Dec 2002
Date Written: May 1999
The paper introduces monetary and fiscal regimes into a Blanchard-Weil overlapping generations model. Contrary to intuition, it is shown that fiscal policy becomes more effective, the less the central bank monetises government debt. Furthermore, there is a degree of debt monetisation at which Ricardian equivalence seems to hold in this "non-Ricardian" model, as fiscal policy is neutral with respect to agent's net wealth. At the origin of these results are the opposite intergenerational wealth effects of money and debt financing. Since, on average, central bank independence increased through EMU, the analysis suggests that fiscal policy might have become a more powerful instrument for euro-area countries. It is further argued that given the Stability and Growth Pact, governments will find it wise to run budget positions "close to balance or in surplus" in order to maintain the increased fiscal policy effectiveness.
Keywords: Monetary and Fiscal Policy Regimes, Fiscal Policy Effectiveness, Ricardian Equivalence, Central Bank Independence, Stability and Growth Pact
JEL Classification: E63
Suggested Citation: Suggested Citation