Reinstating Fiscal Policy as a Stabilisation Device


Background:
A recent discussion paper issued by HM Treasury (2003) has raised the possibility of reinstating a stabilisation role for discretionary fiscal policy. This research project will seek to evaluate such proposals, particularly when monetary policy instruments have been relinquished as part of EMU. We would seek to extend the recent literature on optimal monetary policy, which utilises utility-based measures of welfare in micro-founded general equilibrium models, to allow for a richer description of fiscal policy. Specifically, we would drop the common fiction that fiscal policy can eliminate the distortions due to imperfect competition in labour and product markets through the use of an appropriate combination of subsidies and lump-sum taxation. Instead, we would wish to consider a situation where fiscal instruments are inherently distortionary. Adopting this basic premise, we would then seek to develop a series of models appropriate for assessing the ability of alternative fiscal instruments to perform a stabalisation role. Since the derivation of welfare functions is model specific we would hope to be able to consider which objectives are appropriate to a discretionary fiscal policy in a variety of models (open economy models under EMU, models with capital, models with durable consumption goods etc). We would also wish to develop numerical descriptions of optimal policy in models where analytical derivation of welfare functions is intractable. Finally, within this framework, we would examine specific aspects of recent proposals for reinstating fiscal policy in a stabalisation role. For example, we would investigate under what circumstances adopting a 'trigger strategy' for fiscal policy, whereby discretionary fiscal policy is only implemented for significantly large output gaps, can be justified, and whether or not there is any role for debt targets in enhancing reputation or ensuring intergenerational equity.

Working Papers :

WEF0007
Fiscal Stabilisation Policy and Fiscal Institutions
Campbell Leith & Simon Wren-Lewis
March 2006

WEF0006
Fiscal Sustainability in a New Keynesian Model
Campbell Leith & Simon Wren-Lewis
March 2006

WEF0005
The Costs of Fiscal Inflexibility
Campbell Leith & Simon Wren-Lewis
March 2006


Journals, seminar papers and other publications:

Kirsanova, T., C. Leith and S. Wren-Lewis (2006), “Optimal Debt Policy, and an Institutional Proposal to Help in Its Implementation”, paper invited from presentation at DG EcFIn of the European Commission, Brussels November 2006 on “The Role of National Fiscal Rules and Outcomes in Shaping Budgetary Outcomes”.

Kirsanova, T and Wren-Lewis, S (2006), Optimal Fiscal Feedback on Debt in an Economy with Nominal Rigidities, mimeo, University of Exeter.
 
Kirsanova, T, Satchi, M, Vines, D and Wren-Lewis, S (2007), Optimal Fiscal Policy Rules in a Monetary Union, Journal of Money, Credit and Banking, forthcoming

Kirsanova, T, Leith, C and Wren-Lewis, S (2006), Should Central Banks Target Consumer Prices or the Exchange Rate?, Economic Journal, 116,208-231

Leith, C. and L. von-Thadden, (2006), “Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers”

Leith, C. and S. Wren-Lewis (2006a), “The Costs of Fiscal Inflexibility”, mimeograph, University of Glasgow.

Leith, C. and S. Wren-Lewis (2006b), “Fiscal Sustainability in a New Keynesian Model”, mimeograph, University of Glasgow.

Leith, C. and S. Wren-Lewis (2006), “Fiscal Stabilisation Policy and Fiscal Institutions”, Oxford Review of Economic Policy, vol 21, pp 584-597.

Leith, C. and S. Wren-Lewis (2006), “The Optimal Monetary Policy Response to Exchange Rate Misalignments”, mimeograph, University of Glasgow.

Leith, C. and S. Wren-Lewis (2006), “The Costs of CPI Inflation Targeting”, mimeograph, University of Glasgow

Leith, C. and S. Wren-Lewis (2005), "Fiscal Policy as a Stabilisation Device for an Open Economy Inside or Outside EMU," University of Glasgow Discussion Paper in Economics No. 2005-23.

Leith, C. (2007), “Discussion of the Economic Importance of Fiscal Rules” in Cobham, D. (ed), The Travails of the Eurozone, Pub. Palgrave Macmillan.


Researchers:
Professor Campbell Leith
University of Glasgow

Professor Simon Wren-Lewis
University of Exeter

Contact:
Prof Campbell Leith
Department of Economics
University of Glasgow
Room S111
Adam Smith Buliding
Glasgow
G12 8RT

Tel: 0141 330 3702
email:

Duration of Research:
September 2005 - August 2008