Hostname: page-component-78c5997874-xbtfd Total loading time: 0 Render date: 2024-11-11T05:12:21.110Z Has data issue: false hasContentIssue false
  • English
  • Français

POLITICAL CONFLICT AND BARGAINING IN A NEW KEYNESIAN MODEL OF FISCAL STABILIZATION

Published online by Cambridge University Press:  17 January 2020

Francesca Flamini  and
Campbell Leith
Francesca Flamini
Affiliation:
University of Glasgow
Campbell Leith*
Affiliation:
University of Glasgow
*
Address correspondence to: Campbell Leith, Economics, University of Glasgow, Gilbert Scott Building, Glasgow, G12 8QQ, UK. e-mail: campbell.leith@glasgow.ac.uk.
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

Recent work on optimal monetary and fiscal policy in New Keynesian models has tended to focus on policy set by an infinitely lived benevolent policy maker, often with access to a commitment technology. In this paper, we explore deviations from this ideal, by allowing (time-consistent) policy to be set by a process of bargaining between two political players with different weights on elements of the social welfare function. We characterize the (linear) Markov perfect equilibrium and, in a series of numerical examples, we explore the resultant policy response to shocks which cannot be perfectly offset with the available instruments due to their fiscal consequences. We find that, even although the players, on average, have the socially desirable objective function, the process of bargaining implies an outcome which deviates from the time-consistent policy chosen by the benevolent policy maker. Moreover, the range of instruments available mean that policy makers will bargain across the entire policy mix, sometimes implying outcomes which are quite different from those that would be chosen by a single policy maker. These policy outcomes depend crucially on the nature of the conflict and also the level of government debt.

Keywords

New Keynesian ModelGovernment DebtMonetary PolicyFiscal PolicyBargainingInvestmentRecursive OptimizationMarkov Perfect Equilibrium
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 8 , December 2021 , pp. 2128 - 2179
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted re-use, distribution, and reproduction in any medium, provided the original work is properly cited.
Copyright
© Cambridge University Press 2020

Footnotes

Francesca Flamini and Campbell Leith are grateful to the ESRC, Grant No.s RES 061-23-0084; and RES-156-25-003 and RES-062-23-1436, respectively, for financial assistance. We also thank the editor, two referees, Charles Nolan, Eric Leeper, Gerhard Sorger, and participants at SAET2019 in Ischia for helpful comments. All errors remain ours.

References

REFERENCES

Adam, K. and Billi, R. M. (2014) Distortionary fiscal policy and monetary policy goals. Economics Letters, Elsevier, 122(1), 1–6.CrossRefGoogle Scholar
Admati, A. R. and Perry, M. (1987) Strategic delay in bargaining. Review of Economic Studies 54, 345–364.CrossRefGoogle Scholar
Aiyagari, S. R., Marcet, A., Sargent, T. J. and Seppala, J. (2002) Optimal taxation without state-contingent debt. Journal of Political Economy 110(6), 1220–1254.CrossRefGoogle Scholar
Alesina, A. and Drazen, A. (1991) Why are stabilizations delayed? American Economic Review 81(5), 1170–1188.Google Scholar
Aschauer, D. A. (1985) Fiscal policy and aggregate demand. American Economic Review 75, 117–127.Google Scholar
Bai, Y., Kirsanova, T. and Leith, C. B. (2017) Nominal targeting in an economy with government debt. European Economic Review, Elsevier, 94(C), 103–125.CrossRefGoogle Scholar
Benigno, P. and Woodford, M. (2004) Optimal monetary and fiscal policy: A linear quadratic approach. In: Gertler, M. and Rogoff, K. (eds.), NBER Macroeconomics Annual, vol 18, pp 271–364.CrossRefGoogle Scholar
Bilbiie, F. O., Ghironi, F. and Melitz, M. J. (2008) Monopoly Power and Endogenous Product Variety: Distortions and Remedies. NBER Working paper No. 14383.CrossRefGoogle Scholar
Binmore, K. (1987) Nash bargaining theory II. In: Binmore, K. and Dasgupta, P. (eds.), The Economics of Bargaining, pp. 61–76. Oxford: Basil Blackwell Ltd.Google Scholar
Bowen, T. R., Chen, Y. and Eraslan, H. (2014) Mandatory versus discretionary spending: The status quo effect. American Economic Review 104(10), 2941–2974.CrossRefGoogle Scholar
Cai, H. (2000) Delay in multilateral bargaining under complete information. Journal of Economic Theory 93, 260–276.CrossRefGoogle Scholar
Calvo, G. (1983) Staggered prices in a utility maximising framework. Journal of Monetary Economics 12(3), 383–398.CrossRefGoogle Scholar
Chen, X., Leeper, E. M. and Leith, C. (2017) U.S. Monetary and Fiscal Policies Conflict or Cooperation. Working Paper.Google Scholar
Currie, D. and Levine, P. (1993) Rules, Reputation and Macroeconomic Policy Coordination. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
D’Auria, F. (2015) The effects of fiscal shocks in a new Keynesian model with useful government spending. Macroeconomic Dynamics 19, 1380–1399.CrossRefGoogle Scholar
Diaz-Giminez, J., Giovannetti, G., Marimon, R. and Teles, P. (2008) Nominal debt as a burden on monetary policy. Review of Economic Dynamics 11, 493–514.CrossRefGoogle Scholar
Drazen, A. and Grilli, V. (1993) The benefit of crises for economic reforms. American Economic Review 83(3), 598–607.Google Scholar
Ellison, M. and Rankin, N. (2007) Optimal monetary policy when lump-sum taxes are unavailable: A reconsideration of the outcomes under commitment and discretion. Journal of Economic Dynamics and Control 31(1), 219–243.CrossRefGoogle Scholar
Flamini, F. (2012) Recursive bargaining with dynamic accumulation. In: Johansoon, R. and Rantzer, A. (eds.), Distributed Decision Making and Control, Lecture Notes in Control and Information Sciences, vol. 417, pp. 131–144. London: Springer.CrossRefGoogle Scholar
Gali, J. (1994) Government size and macroeconomic stability. European Economic Review 28, 117–132.CrossRefGoogle Scholar
Heer, B. and Maussner, A. (2009) Dynamic General Equilibrium Modelling, 2nd ed. London: Springer.CrossRefGoogle Scholar
Hsieh, C. T. (2000) Bargaining over reform. European Economic Review 44(9), 1659–1676.CrossRefGoogle Scholar
Karras, G. (1994) Government spending and private consumption: Some international evidence. Journal of Money, Credit and Banking 26(1), 9–22.CrossRefGoogle Scholar
Katayama, K. (2008) Delay Fiscal Reform. Policy Research Institute Discussion Paper Series No. 08A-06, Ministry of Finance, Japan.Google Scholar
Klein, P., Krusell, P. and Rios Rull, J. V. (2008) Time consistent public policy. Review of Economic Studies 75, 1217–1246.CrossRefGoogle Scholar
Leeper, E. M. (1991) Equilibria under ‘active’ and ‘passive’ monetary and fiscal policies. Journal of Monetary Economics 27, 129–147.CrossRefGoogle Scholar
Leeper, E. M. and Leith, C., (2016) Understanding inflation as a joint monetary and fiscal phenomenon. In: Handbook of Macroeconomics, Chapter 30, vol. 2, pp. 2305–2415. Elsevier.Google Scholar
Leeper, E. M., Leith, C. and Liu, D. (2016) Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy. Working Papers 2016_04, Business School – Economics, University of Glasgow.CrossRefGoogle Scholar
Leeper, E. M., Traum, N. and Walker, T. B. (2017) Clearing up the fiscal multiplier morass. American Economic Review 107(8), 2409–2454.CrossRefGoogle Scholar
Leith, C. and Malley, J. (2005) Estimated general equilibrium models for the analysis of monetary policy in the US and Europe. European Economic Review 49(8), 2137–2159.CrossRefGoogle Scholar
Leith, C. and Wren-Lewis, S. (2013) Fiscal sustainability in a New Keynesian model. Journal of Money, Credit and Banking, Blackwell Publishing, 45(8), 1477–1516.CrossRefGoogle Scholar
Levine, P, McAdam, P. and Pearlman, J. (2008) Quantifying and sustaining welfare gains from monetary commitment. Journal of Monetary Economics 55(7), 1253–1276.CrossRefGoogle Scholar
Levine, P and Pearlman, J. (2011) Computation of LQ Approximations to Optimal Policy Problems in Different Information Settings under Zero Lower Bound Constraint. Dynare Working Paper No. 10.Google Scholar
Lucas, R. E. and Stokey, N. (1983) Optimal fiscal and monetary policy in an economy without capital. Journal of Monetary Economics 12(1), 55–93.CrossRefGoogle Scholar
Martin, F. (2009) A positive theory of government debt. Review of Economic Dynamics 12(4), 608–631.CrossRefGoogle Scholar
Martinelli, C. and Escorza, R. (2007) When are stabilizations delayed? Alesina–Drazen revisited. European Economic Review 51(5), 1223–1245.CrossRefGoogle Scholar
Muthoo, A. (1995) Bargaining in a long run relationship with endogenous termination. Journal of Economic Theory 66(2), 590–598.CrossRefGoogle Scholar
Muthoo, A. (1999) Bargaining Theory with Applications. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
Nicolini, J. P. (1998) More on the time consistency of monetary policy. Journal of Monetary Economics 41(2), 333–350.CrossRefGoogle Scholar
Niemann, S. and Pilcher, P. (2011) Optimal fiscal and monetary policy under rare disasters: The role of government debt and monetary conservatism. European Economic Review 55(1), 75–92.CrossRefGoogle Scholar
Niemann, S., Pilcher, P. and Sorger, G. (2013a) Central bank independence and the monetary instrument problem. International Economic Review 54, 1031–1055.CrossRefGoogle Scholar
Niemann, S., Pichler, P. and Sorger, G. (2013b) Public debt, discretionary policy, and inflation persistence. Journal of Economic Dynamics and Control 37(6), 1097–1109.CrossRefGoogle Scholar
Obstfeld, M. (1991) A model of currency depreciation and the debt-inflation sprial. Journal of Economic Dynamics and Control 15(1), 151–177.CrossRefGoogle Scholar
Obstfeld, M. (1997) Dynamic seigniorage theory: An exploration. Macroeconomic Dynamics 1, 588–614.CrossRefGoogle Scholar
Orphanides, A. (1996) The timing of stabilizations. Journal of Economic Dynamics and Control 20(1–3), 257–279.CrossRefGoogle Scholar
Osborne, G. (2010) Mais Lecture – A New Economic Model, February 24, 2010.Google Scholar
Rogoff, K. (1985) The Optimal Degree of Commitment to an Intermediate Monetary Target. Quarterly Journal of Economics 100, 1169–1189.CrossRefGoogle Scholar
Rotemberg, J and Woodford, M. (1997) An optimisation-based econometric framework for the evaluation of monetary policy. In: Bernanke, B. S. and Rotemberg, J. (ed.), NBER Macroeconomic Annual, pp. 297–346. Cambridge, MA: MIT Press.Google Scholar
Rubinstein, A. (1982) Perfect equilibrium in a bargaining game. Econometrica 50(1), 97–109.CrossRefGoogle Scholar
Schmitt-Grohe, S. and Uribe, M. (2004) Optimal monetary and fiscal policy under sticky prices. Journal of Economic Theory 114(2), 198–230.CrossRefGoogle Scholar
Sibert, A. and Perraudin, W. (2000) Timing of multilateral lending. Economic Journal 110, 192–211.Google Scholar
Sorger, G. (2006) Recursive Nash bargaining over a productive asset. Journal of Economic Dynamic and Control 30, 2637–2659.CrossRefGoogle Scholar
Spolaore, E. (2004) Adjustments in different government systems. Economics and Politics 16(2), 117–146.CrossRefGoogle Scholar
Velasco, A. (2000) Debts and deficits with fragmented fiscal policymaking. Journal of Public Economics 76(1), 105–125.CrossRefGoogle Scholar
Woodford, M. (2003) Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton: Princeton University Press.Google Scholar