Pareto Improving Fiscal and Monetary Policies: Samuelson in the New Keynesian Model
Paper joint with Mark Aguiar and Cristina Arellano.
Abstract:
This paper explores the normative and positive consequences of government bond issuances in a New Keynesian model with heterogeneous agents, focusing on how the stock of government bonds affects the cross-sectional allocation of resources in the spirit of Samuelson (1958). We characterize the Pareto optimal levels of government bonds and the associated monetary policy adjustments that should accompany Pareto-improving bond issuances. The paper introduces a simple phase diagram to analyze the global equilibrium dynamics of inflation, interest rates, and consumption in response to changes in the stock of government debt. It provides a tractable tool to explore the use of fiscal policy to escape the Effective Lower Bound (ELB) on nominal interest rates and the resolution of the “forward guidance puzzle.” We show how the fiscal policy stance matters for the effectiveness of the latter. A common theme throughout is that following the monetary policy guidance from the standard Ricardian framework leads to excess fluctuations in inflation and consumption.
Sponsored by CEDEC.