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Active fiscal policy and macroeconomic stability

Research paper by Purpose The purpose of this paper is to investigate whether fiscal policy may be a complementary instrument to monetary policy in the macrostabilization process. Design/methodology/approach The authors developed a dynamic system with two linear differential equations in order to verify if an active fiscal policy can be compatible with macroeconomic equilibrium in three monetary policy regimes (conservative, alternative and hybrid). The authors also use numerical simulations because it is impossible to extract analytically full conclusions from the theoretical model. Findings The results suggest that fiscal policy can be a useful tool for macroeconomic stabilization; the counter-cyclical role of fiscal policy is compatible with dynamic equilibrium only if the monetary authority is not lenient towards inflation; and under an active fiscal policy a hybrid monetary regime is preferable to a conserva

Indexed on: 06 Nov '16Published on: 14 Sep '16Published in: Journal of economic studies (Glasgow, Scotland)



Abstract

Journal of Economic Studies, Volume 43, Issue 5, Page 749-762, October 2016. Purpose The purpose of this paper is to investigate whether fiscal policy may be a complementary instrument to monetary policy in the macrostabilization process. Design/methodology/approach The authors developed a dynamic system with two linear differential equations in order to verify if an active fiscal policy can be compatible with macroeconomic equilibrium in three monetary policy regimes (conservative, alternative and hybrid). The authors also use numerical simulations because it is impossible to extract analytically full conclusions from the theoretical model. Findings The results suggest that fiscal policy can be a useful tool for macroeconomic stabilization; the counter-cyclical role of fiscal policy is compatible with dynamic equilibrium only if the monetary authority is not lenient towards inflation; and under an active fiscal policy a hybrid monetary regime is preferable to a conservative one. Originality/value This paper offers a theoretical contribution to explicate the macroeconomic implications of fiscal policy.