This document summarizes a paper on fiscal and monetary policy rules in an unstable economy. It begins by outlining Harrodian instability and consumption/investment behavior. It then examines different policy rules, finding that a Taylor rule is not stabilizing when debt is high, while a "Keynesian policy rule" where government consumption stabilizes employment is stabilizing. An "austerity policy rule" aiming to keep debt ratios constant is destabilizing and aggravates Harrodian instability. The document concludes that automatic stabilizers are insufficient and policy is needed to remove instability, with the paper extending the analysis to interactions of fiscal and monetary policy rules.
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Fiscal and monetary policy rules in an unstable economy
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
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
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
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
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