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Fiscal and monetary policy rules in an unstable economy

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Information about Fiscal and monetary policy rules in an unstable economy
Economy & Finance

Published on October 15, 2014

Author: pkconference

Source: slideshare.net

Description

Functional Finance and Monetary Policy session at 12th International Conference
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1. Fiscal and monetary policy rules 1 in an unstable economy Soon Ryoo Peter Skott Adelphi University Umass and Aalborg University 12th International Post Keynesian Conference UMKC, September 2014

2. Overview  Harrodian instability  Consumption and investment  Monetary and fiscal policy rules  Conclusions 2

3. HARRODIAN BENCHMARK 3

4. Basic equations  Investment  Consumption  Equilibrium condition 4 ġ u ud C K 1su u  g s

5. Harrodian problems  Warranted vs natural growth  Unstable dynamics 5 gw sud  n ġ  g  s ud; 0

6. Reconciling natural and warranted rates  Interest rates  Choice of technique  ‘Optimal’ fixed Leontief production function  Fiscal policy  Deficit if private saving exceeds investment at full employment  Implications for  Consumption behavior and goods market equilibrium  Debt dynamics 6

7. Steady growth results  OLG setting:  empirical relevance of ‘dynamic inefficiency’  dynamic inefficiency implies AD problems  ‘Stock-flow consistent’ setting  Robust across models:  Low growth causes high debt  High government consumption causes low debt  Why?  With higher I or G, full-employment consumption needs to get squeezed → higher taxes 7

8. Short-run stabilization?  Automatic fiscal stabilizers  Are they sufficient?  Do monetary Taylor rules stabilize?  Taylor rule for fiscal policy?  Supercharged fiscal stabilizer 8

9. MODEL 9

10. Policy instruments  Monetary:  Real interest rate, r  Fiscal  Government consumption, G; γ=G/K  Proportional tax rate, τ 10

11. Consumption: taxes, interest and wealth  Target consumption-wealth ratios  Gradual adjustment pB  Budget constraint 11 B   pC vN   pC # # B B B B pYD pC vN 

12. Consumption function  Assume investment financed by retained earnings (adjustments in retention rate)  Then:  Note:  The equity ratio α is irrelevant  Public debt has income and wealth effects  Consumption rates depend on β. 12 pC 1 c pY rBcpI cvB c 1/1and cv  /1

13. Investment  Excess capacity desired because of  Demand volatility  Entry deterrence  …  Weigh cost of holding excess capacity against the benefits  Desired utilization depends on cost of finance: 13 ġ uud ud u rr

14. Dynamic system  Investment dynamics  Debt dynamics ġ u ud ud u r u c1  b u rbcb cg rgburb  Employment dynamics 14 r  k kgn e uk where k K/L g 

15. IMPLICATIONS 15

16. Taylor rule  3D system if ρ3=0  Local stability possible if desired utilization sufficiently sensitive to changes in r  Threshold value depends on debt ratio  High debt ratio endangers stability  Intuition  Expansionary induced fiscal effect 16 r r 1  u2 u k3 kppT

17. Keynesian policy rule  Government consumption as active instrument  Full stabilization of employment at e* -- γ set to give u=e*/k -- is possible but implies:  2D system in (g,k)  Lotka-Volterra structure and conservative fluctuations 17

18. Modified Keynesian rule  Use γ to get  2D system in (g,k)  Locally stable  Induced b-dynamics is stable for plausible parameter values 18 u g,b, u Hkk,g n,H1 0,H2 0,H 0,00

19. Austerity rule  Extreme version: keep B/Y constant  Unstable 2D system in (g,b)  Arbitrary B/Y target fails to ensure g*=n  Modified version: keep b=B/K constant  Unstable; Harrodian instability aggravated 19

20. CONCLUSIONS AND EXTENSIONS 20

21. Conclusions  Need for policy  Automatic stabilizers dampen effects of shocks but fail to remove Harrodian instability  Taylor rule is not stabilizing when debt ratios are high  ‘Keynesian policy rule’ is stabilizing  ‘Austerity policy rule’ is de-stabilizing 21

22. Extensions  Interactions between fiscal policy and ‘Taylor rule’  Inflation dynamics  Other stabilizing mechanisms  ‘reserve army effects’  Fiscal rules in ‘full’ cycle model  Empirics on ‘implicit fiscal policy rules’ 22

23. THANKS! 23

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