Monetary-Fiscal Policy Interactions And Fiscal Stimulus

40 Pages Posted: 18 Aug 2009

See all articles by Eric M. Leeper

Eric M. Leeper

University of Virginia ; Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER); George Mason University - Mercatus Center

Troy Davig

Federal Reserve Bank of Kansas City

Multiple version iconThere are 3 versions of this paper

Date Written: June 25, 2009

Abstract

Increases in government spending trigger substitution effects — both inter- and intra-temporal — and a wealth effect. The ultimate impacts on the economy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes create a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between active and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model’s predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act’s implied path for government spending under alternative monetary-fiscal policy combinations.

Keywords: multipliers, zero interest rate bound, fiscal stimulus

JEL Classification: E52, E62, E63

Suggested Citation

Leeper, Eric Michael and Davig, Troy, Monetary-Fiscal Policy Interactions And Fiscal Stimulus (June 25, 2009). CAEPR Working Paper No. 010-2009, Available at SSRN: https://ssrn.com/abstract=1456355 or http://dx.doi.org/10.2139/ssrn.1456355

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