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In pursuing a steady-state reserve target, policymakers in small open economies can resort to devaluation or to temporary increases in public saving. This paper contrasts the dynamic implications of these alternative policies in a model with optimizing agents who possess perfect foresight. In general, the private sector cannot be insulated from the effects of the government’s reserve-accumulation policies. The dynamic effects of devaluation depend on the fiscal policy rule in effect. In contrast to devaluation, the “equivalent” fiscal policies imply discontinuities in private consumption and temporary tax increases may cause key macroeconomic variables to overshoot their steady-state values.
We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fisscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.
Effects of different policy rules are simulated: uncoordinated targeting of the money supply or nominal income, use of monetary policy to achieve coordinated targets for nominal or real exchange rates, and the use of monetary and fiscal policies to hit targets for internal and external balance. The following conclusions emerge: rules which performed best for some shocks performed poorly for others; monetary policy was ineffective in limiting movements in real exchange rates; unconstrained use of fiscal policy was quite powerful in influencing real variables; and dynamic instability was a potentially serious problem. Robustness to different specifications and to constraints on instruments remains to be examined.
The recent boom and bust in commodity prices has raised concerns about the impact of volatile commodity prices on Latin American countries’ fiscal positions. Using a novel quarterly data set-which includes unique country-specific commodity price indices and a comprehensive measure of public expenditures-this paper analyzes the dynamic effects of commodity price fluctuations on fiscal revenues and expenditures for eight commodity-exporting Latin American countries. The results indicate that Latin American countries’ fiscal positions react strongly to shocks to commodity prices, yet there are marked differences across countries. Fiscal variables in Venezuela display the highest sensitivity to commodity price shocks, with expenditures reacting significantly more than revenues. At the other end of the spectrum, in Chile expenditure reacts very little to commodity price fluctuations, and the dynamic responses of its fiscal indicators are very similar to those seen in high-income commodity-exporting countries. This distinct behavior across countries may relate to institutional arrangements, which in some cases include the efficient application of fiscal rules amid political commitment and high standards of transparency.
This paper reviews the theoretical and empirical literature on the effectiveness of fiscal policy. The focus is on the size of fiscal multipliers, and on the possibility that multipliers can turn negative (i.e., that fiscal contractions can be expansionary). The paper concludes that fiscal multipliers are overwhelmingly positive but small. However, there is some evidence of negative fiscal multipliers.
This is the first of two volumes on a theory of macroeconomic policy that analyzes which policies are credible or politically feasible. Instead of looking at policy as an end product, the contributors approach policy as an ongoing process of revised goals, changes in tactics, and political pressures. They consider what kinds of incentives within different institutional settings, drive policy-making and the behaviour of policy-makers. The approach explains why certain monetary and fiscal policies are implemented, and provides insights into situations that occur repeatedly in macroeconomic policy, such as the bias toward government deficits, partisan competition and central bank independence.