Browsing by Subject "DSGE"

Now showing 1 - 1 of 1

A monetary-fiscal theory of prices in modern DSGE models
(2018) Schröder, Christian Philipp; Spahn, Peter
Starting with the Eurozone crisis in 2010, fiscal variables such as the government budget position and public debt of certain member countries as well as the design of the European Monetary Union as a whole came under close scrutiny again. Furthermore, as a consequence of the global financial crisis, the economic profession faced accusations that, using the established ‘workhorse models,’ it was not able to provide answers to the pertinent questions of the time. From the perspective of economic theory, two main issues can be outlined against this background: (1) How do the so-called DSGE (dynamic stochastic general-equilibrium) models work which form a quasi-consensus in practice, research, and teaching nowadays? This relates especially to determinacy, that is, the mathematical property of being able to draw unique conclusions from a given set of assumptions. (2) What roles do the main fields of macroeconomic policy---fiscal and monetary policy---play in this? The exposition of these items is carried out within a formally consistent theoretical model which adheres to common standards and strikes a balance between staying general enough for a broad range of approaches and being sufficiently specific to yield tangible results. Following a brief introduction, Chapter 2 presents a microfounded (‘baseline’) general-equilibrium model that acts as a foundation for subsequent analysis. The only substantial exception is the excursus in Chapter 3. It deals with interactions between the entities of the consolidated government sector, namely the treasury and the central bank, and in doing so also touches on traditional models which cannot be reconciled entirely with modern theory. One of the main aspects is the “unpleasant monetarist arithmetic” that describes the long-standing explanation for fiscally induced inflation. The fourth chapter then takes up the baseline model and ‘closes’ it by defining monetary as well as fiscal policy, both of which can be active (that is, dominant) or passive. Resulting from this classification are two stable macroeconomic regimes (monetary or fiscal dominance) plus two undesirable outcomes (explosive instability or indeterminacy of central model variables). Monetary dominance is tantamount to the prevailing world view—central banks can independently pursue a measure of price stability while governments have to follow a sustainable (Ricardian) fiscal policy—whereas fiscal dominance gives rise to a “fiscal theory of the price level” in which the treasury sets budget surpluses without regard for other variables and monetary policy can be an implicit accomplice at most. This latter regime ultimately puts price stability into the hands of the treasury. Initially, the only public liability is debt (there is no money at this stage); however, the is model is able to determine unique price levels in the stable regimes. Chapter 5 introduces several isolated complications to the model described so far. One is the role of money, especially in the fiscalist model variant; it shows that the main results remain unchanged if monetary policy is conducted via money-supply instead of interest-rate policy. Further considerations are the zero lower bound on interest rates (in a graphic analysis) as well as limits to public-sector liabilities. Subsequently, Chapter 6 applies the baseline model of Chapter 2 to the open economy—more precisely, a monetary union consisting of two countries. Since monetary policy is supranational here, outcomes crucially depend on national fiscal policies. While the baseline model assumes flexible prices, Chapter 7 adds the considerable complication of nominally rigid prices. A mostly ‘plain-vanilla’ New-Keynesian model emerges which, following common practice, is then linearized and simulated in Matlab/Dynare. At the core of the analysis lie the two stable regimes carved out in Chapter 4. The central implications of the monetary-fiscal theory derived so far are adjusted gradually, but remain in place generally. Towards the end, the thesis highlights empirical issues (verifiability of the regimes, historical case studies). Finally, the results obtained beforehand culminate in a comprehensive discussion of the monetary-fiscal theory, including a distinction from traditional approaches. Chapter 10 concludes.