This paper investigates the stabilizing role of monetary policy in a dynamic, stochastic general equilibrium model of the “natural rate”, in which non indexed nominal wages are periodically set by labor market “insiders”. This nominal distortion allows for nominal shocks to have temporary real effects, and thus, for monetary policy to be able to affect short run fluctuations in both inflation and real output. We derive and analyze optimal monetary policy in the presence of real and nominal shocks, and highlight the properties of the optimal monetary policy rule. The optimal policy rule is second best, as it cannot completely neutralize productivity shocks, and is associated with a tradeoff between the stabilization of inflation and output. We also demonstrate that the optimal policy can be replicated by a set of appropriately parametrized Taylor rules, according to which deviations of the current nominal interest rate from its “natural” rate, depend on deviations of inflation from target and output from its “natural” level. We prove that the optimal Taylor rule is not unique, as multiple sets of parameters are consistent with optimality. Provided that the monetary authorities attach a sufficiently low weight to deviations of output from its “natural” level, the optimal policy could also be replicated through a unique, appropriately parametrized Wicksell rule, according to which deviations of the nominal interest rate from its “natural” rate depend only on deviations of inflation from target. The optimal set of Taylor rules is a set of simple, but not too simple rules, as, the nominal interest rate must react to changes in the “natural” rate of interest, in addition to deviations of inflation from target, and output from its “natural”level.
Discussion Paper no. 5-2015, Department of Economics, Athens University of Economics and Business
PDF of Revised Paper, May 2016
This paper compares financial openness with autarky in a neoclassical growth model, with adjustment costs for investment. We analyse the relation between growth and the current account in the transition towards the balanced growth path, and derive the implications of the two financial regimes for the balanced growth path. For an economy with an initial capital stock which is lower than the rest of the world, output (GDP) per capita on the balanced growth path is the same under financial openness and autarky. However, Gross National Product (GNP) and consumption per capita are lower under financial openness than under autarky. The reason is that the economy has to pay interest on the foreign debt it has accumulated during the transition. During the transition, the economy runs current account deficits and accumulates net foreign debt. The opposite applies to an economy, whose initial capital stock is higher than the rest of the world. There are benefits from financial openness and inter-temporal trade for either type of economy, as, during the transition, the path of the world real interest rate differs from the path of autarky real interest rates for either type of economy.
This paper focuses on an econometric investigation of the macroeconomic and political factors that contributed to Greece’s excessive debt accumulation and its failure to adequately address its fiscal imbalances, from the restoration of democracy in 1974 till the crisis of 2009. The econometric investigation is based on a model in which two political parties alternate in power, and in which governments choose primary expenditure and taxes to minimize deviations from politically determined expenditure and tax targets, subject to a debt accumulation equation. The model predicts a political equilibrium in which primary expenditure and taxes follow feedback rules which go in the direction of stabilizing the debt to GDP ratio. However, this stabilization incentive is weaker in election years. The model also predicts potential partisan differences in the evolution of primary expenditure and taxes, due to the different preferences of political parties. Estimates of government reaction functions to public debt for the period 1975-2009 suggest a rather weak stabilizing reaction of primary deficits to public debt. This stabilizing reaction disappears in election years, which are characterized by strong fiscal expansions. We find no evidence of partisan differences in the reaction of primary deficits to inherited debt, but we do find evidence of lower primary deficits in the post-1992 Maastricht treaty period. Overall the model accounts for the accumulation of Greece’s government debt in terms of the trend increase in primary expenditure, the positive shocks to primary expenditure in election years and the weak stabilizing reaction of government revenue, due to tax smoothing.
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GreeSE Paper no. 68, Hellenic Observatory, London School of Economics
Discussion Paper no. 10-13, Department of Economics, Athens University of Economics and Business