Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities

34 Pages Posted: 8 Nov 2006 Last revised: 6 Jul 2014

See all articles by Tatiana Kirsanova

Tatiana Kirsanova

University of Glasgow

Simon Wren-Lewis

University of Oxford - Economics Department

Multiple version iconThere are 2 versions of this paper

Date Written: August 6, 2010

Abstract

We examine the impact of different degrees of fiscal feedback on debt in an economy with nominal rigidities where monetary policy is determined optimally, rather than following a simple rule. We look at the extent to which different degrees of fiscal feedback enhances or detracts from the ability of the monetary authorities to stabilise output and inflation. Using an objective function derived from utility, we find the optimal level of fiscal feedback to be small. There is a clear discontinuity in the behaviour of monetary policy and welfare either side of this optimal level. As the extent of fiscal feedback increases, optimal monetary policy becomes less active because fiscal feedback tends to deflate inflationary shocks. However this fiscal stabilisation is less efficient than monetary stabilisation, and so welfare declines. In contrast, if fiscal feedback falls below some critical value optimal monetary policy becomes strongly passive, and this passive monetary policy leads to a sharp deterioration in welfare.

Keywords: Fiscal Policy, Feedback Rules, Debt, Macroeconomic Stabilisation

JEL Classification: E52, E61, E63, F41

Suggested Citation

Kirsanova, Tatiana and Wren-Lewis, Simon J.Q., Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities (August 6, 2010). Available at SSRN: https://ssrn.com/abstract=943030 or http://dx.doi.org/10.2139/ssrn.943030

Tatiana Kirsanova (Contact Author)

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

Simon J.Q. Wren-Lewis

University of Oxford - Economics Department ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

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