Monetary-Fiscal Policy Interactions and Indeterminacy in Postwar US Data

Bhattarai, Saroj; Lee, Jae Won; Park, Woong Yong

doi:10.1257/aer.102.3.173

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American Economic Review: Vol. 102 No. 3 (May 2012)

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Monetary-Fiscal Policy Interactions and Indeterminacy in Postwar US Data

Article Citation

Bhattarai, Saroj, Jae Won Lee, and Woong Yong Park. 2012. "Monetary-Fiscal Policy Interactions and Indeterminacy in Postwar US Data." American Economic Review, 102(3): 173-78.

DOI: 10.1257/aer.102.3.173

Abstract

Using a micro-founded model and a likelihood-based inference method, we show that while a passive monetary and passive fiscal policy regime prevailed in the U.S. before Paul Volcker's chairmanship at the Federal Reserve, an active monetary and passive fiscal policy regime prevailed after his appointment. Since both monetary and fiscal policies were passive pre-Volcker, equilibrium indeterminacy was a feature of the economy. Finally, pre-Volcker, the effects of unanticipated policy shifts were substantially different from those predicted by conventional monetary models: unanticipated increases in interest rates increased inflation and output, while unanticipated increases in lump-sum taxes decreased inflation and output.

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Authors

Bhattarai, Saroj (PA State U)
Lee, Jae Won (Rutgers U)
Park, Woong Yong (U Hong Kong)

JEL Classifications

E13: General Aggregative Models: Neoclassical
E52: Monetary Policy
E62: Fiscal Policy