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Working Paper
Saving for a rainy day: estimating the appropriate size of U.S. state budget stabilization funds
Rainy day funds (RDFs) are potentially an important countercyclical tool for states to stabilize their budgets and the overall economy during economic downturns. However, U.S. states have often found themselves exhausting their RDFs and having to raise tax rates or reduce expenditures while still experiencing a downturn. Therefore, how much each state should save in its RDF has become an increasingly important policy question. To address this issue, this paper applies several new methodologies to develop target RDF levels for each U.S. state, based on the estimated short-term revenue component associated with business cycles and also on policymakers' preferences for stable tax rates and expenditures.
AUTHORS: Zhao, Bo
DATE: 2014-10-01

Working Paper
Quantitative Easing in Joseph's Egypt with Keynesian Producers
This paper considers monetary and fiscal policy when tangible assets can be accumulated after shocks that increase desired savings, like Joseph's biblical prophecy of seven fat years followed by seven lean years. The model?s flexible-price allocation mimics Joseph?s saving to smooth consumption. With nominal rigidities, monetary policy that eliminates liquidity traps leaves the economy vulnerable to confidence recessions with low consumption and investment. Josephean Quantitative Easing, a fiscal policy that purchases either obligations collateralized by tangible assets or the assets themselves, eliminates both liquidity traps and confidence recessions by putting a floor under future consumption. This requires no commitment to a time-inconsistent plan.
AUTHORS: Campbell, Jeffrey R.
DATE: 2014-11-05

Working Paper
Escaping the Great Recession
While high uncertainty is an inherent implication of the economy entering the zero lower bound, deflation is not, because agents are likely to be uncertain about the way policymakers will deal with the large stock of debt arising from a severe recession. We draw this conclusion based on a new-Keynesian model in which the monetary/fiscal policy mix can change over time and zero-lower-bound episodes are recurrent. Given that policymakers? behavior is constrained at the zero lower bound, beliefs about the exit strategy play a key role. Announcing a period of austerity is detrimental in the short run, but it preserves macroeconomic stability in the long run. A large recession can be avoided by abandoning fiscal discipline, but this results in a sharp increase in macroeconomic instability once the economy is out of the recession. Contradictory announcements by the fiscal and monetary authorities can lead to high inflation and large output losses. The policy trade-off can be resolved by committing to inflate away only the portion of debt resulting from an unusually large recession.
AUTHORS: Melosi, Leonardo; Bianchi, Francesco
DATE: 2014-08-01

Working Paper
Fiscal Stimulus with Learning-By-Doing
Using a Bayesian SVAR analysis, we document that an increase in government purchases raises private consumption, the real wage and total factor productivity (TFP) while reducing inflation. Each of these facts is hard to reconcile with both neoclassical and New-Keynesian models. We extend a standard New-Keynesian model to allow for skill accumulation through past work experience, following Chang, Gomes and Schorfheide (2002). An increase in government spending increases hours and induces skill accumulation and higher measured TFP and real wages in subsequent periods. Future marginal costs fall lowering future expected inflation and, through the monetary policy rule, the real interest rate. Consumption increases as a result.
AUTHORS: Fella, Giulio; Melosi, Leonardo; dAlessandro, Antonello
DATE: 2018-05-01

Working Paper
Hitting the Elusive Inflation Target
Since the 2001 recession, average core inflation has been below the Federal Reserve?s 2% target. This deflationary bias is a predictable consequence of a low nominal interest rates environment in which the central bank follows a symmetric strategy to stabilize inflation. The deflationary bias increases if macroeconomic uncertainty rises or the natural real interest rate falls. An asymmetric rule according to which the central bank responds less aggressively to above-target inflation corrects the bias and allows inflation to converge to the central bank?s target. We show that adopting this asymmetric rule improves welfare and reduces the risk of self-fulfilling deflationary spirals. This approach does not entail any history dependence in setting the policy rate or any commitment to overshoot inflation after periods in which the lower bound constraint was binding.
AUTHORS: Bianchi, Francesco; Melosi, Leonardo; Rottner, Matthias
DATE: 2019-08-30

Working Paper
The Fiscal Theory of the Price Level in a World of Low Interest Rates
A central equation for the fiscal theory of the price level (FTPL) is the government budget constraint (or "government valuation equation"), which equates the real value of government debt to the present value of fiscal surpluses. In the past decade, the governments of most developed economies have paid very low interest rates, and there are many other periods in the past in which this has been the case. In this paper, we revisit the implications of the FTPL in a world where the rate of return on government debt may be below the growth rate of the economy, considering different sources for the low returns: dynamic inefficiency, the liquidity premium of government debt, or its favorable risk profile.
AUTHORS: Bassetto, Marco; Cui, Wei
DATE: 2017-11-16

Working Paper
The Dire Effects of the Lack of Monetary and Fiscal Coordination
What happens if the government?s willingness to stabilize a large stock of debt is waning, while the central bank is adamant about preventing a rise in inflation? The large fiscal imbalance brings about inflationary pressures, triggering a monetary tightening, further debt accumulation, and additional inflationary pressure. Thus, the economy will go through a spiral of higher inflation, output contraction, and further debt accumulation. A coordinated commitment to inflate away the portion of debt resulting from a large recession leads to better macroeconomic outcomes by separating the issue of long-run fiscal sustainability from the need for short-run fiscal stabilization. This strategy can also be used to rule out episodes in which the central bank becomes constrained by the zero lower bound.
AUTHORS: Bianchi, Francesco; Melosi, Leonardo
DATE: 2017-07-06

Working Paper
Escaping the Great Recession
We show that policy uncertainty about how the rising public debt will be stabilized accounts for the lack of deflation in the US economy at the zero lower bound. We first estimate a Markov-switching VAR to highlight that a zero-lower-bound regime captures most of the comovements during the Great Recession: a deep recession, no deflation, and large fiscal imbalances. We then show that a micro-founded model that features policy uncertainty accounts for these stylized facts. Finally, we highlight that policy uncertainty arises at the zero lower bound because of a trade-off between mitigating the recession and preserving long-run macroeconomic stability.
AUTHORS: Bianchi, Francesco; Melosi, Leonardo
DATE: 2016-09-16

Working Paper
Inflation dynamics: the role of public debt and policy regimes
We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the equilibrium response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the equilibrium response of inflation to non-policy shocks. Moreover, a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy stances affect inflation dynamics, but because of a role for self-fulfilling beliefs due to equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a richer quantitative model.
AUTHORS: Park, Woong Yong; Bhattarai, Saroj; Lee, Jae Won
DATE: 2012

Working Paper
Fiscal stabilization with partial exchange rate pass-through
This paper examines the role of fiscal stabilization policy in a two-country framework that allows for a general degree of exchange rate pass-through. I derive analytical solutions for optimal monetary and fiscal policy which are shown to depend on the degree of pass-through. In the case of partial pass-through, an optimizing policy maker uses countercyclical fiscal stabilization in addition to monetary stabilization. However, in the extreme cases of complete or zero pass-through, the fiscal stabilization instrument is not employed. There is also no additional gain from the fiscal instrument in the case of coordination between the two countries. These results are due to the specific way the optimal fiscal policy rule affects marginal costs: Rather than being a substitute for monetary policy, fiscal policy complements it by increasing the correlation of the marginal cost terms within and across countries. This in turn makes monetary policy more effective at stabilizing them.
AUTHORS: Kersting, Erasmus K.
DATE: 2009

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