Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints

41 Pages Posted: 5 Feb 2006

See all articles by Anton Muscatelli

Anton Muscatelli

University of Glasgow - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Patrizio Tirelli

Department of Economics and Management; Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

Carmine Trecroci

University of Brescia

Date Written: January 2006

Abstract

This paper derives a New Keynesian dynamic general equilibrium model with liquidity-constrained consumers and sticky prices. The model allows a role for both government spending and taxation in the DGE model. The model is then estimated using US data. We find that rule-of-thumb consumers play a significant role in determining aggregate consumption. Our model is subsequently used to analyse the interaction between fiscal and monetary policies. We demonstrate the extent to which fiscal policy (automatic stabilisers) assist or hinder monetary policy when the latter takes a standard forward-looking inflation targeting form. We also investigate the extent to which inertia in fiscal policy and the existence of rule-of-thumb consumers affect output and inflation variability in the presence of such a monetary policy rule.

JEL Classification: E58, E62, E63

Suggested Citation

Muscatelli, Vito Anton and Tirelli, Patrizio and Trecroci, Carmine, Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints (January 2006). Available at SSRN: https://ssrn.com/abstract=880084 or http://dx.doi.org/10.2139/ssrn.880084

Vito Anton Muscatelli (Contact Author)

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Patrizio Tirelli

Department of Economics and Management ( email )

Corso Strada Nuova, 65
27100 Pavia, 27100
Italy

HOME PAGE: http://https://sites.google.com/site/patriziotirellihomepage/

Università degli Studi di Milano-Bicocca - Center for European Studies (CefES)

U6 Building
Viale Piero e Alberto Pirelli, 22
Milano, 20126
Italy

Carmine Trecroci

University of Brescia ( email )

Via San Faustino 74B
Brescia, 25122
Italy

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