Published on October 15, 2014
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 1su 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 pB 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 rBcpI cvB c 1/1and 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 uud ud u rr
14. Dynamic system Investment dynamics Debt dynamics ġ u ud ud u r u c1 b u rbcb cg rgburb Employment dynamics 14 r k kgn 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 u2 u k3 kppT
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 Hkk,g n,H1 0,H2 0,H 0,00
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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DEPARTMENT OF ECONOMICS . Working Paper . UNIVERSITY OF MASSACHUSETTS AMHERST . Fiscal and monetary policy rules in an unstable economy . by . Ryoo, Soon
How to Cite. Ryoo, S. and Skott, P. (2016), Fiscal and Monetary Policy Rules in an Unstable Economy. Metroeconomica. doi: 10.1111/meca.12139
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