Essays on contemporary monetary and fiscal policies

Karaferis, Vasileios Rafail (2024) Essays on contemporary monetary and fiscal policies. PhD thesis, University of Glasgow.

Abstract

The thesis consists of three chapters. All chapters study monetary and fiscal policy interactions in tractable heterogeneous agent economies. Tractable Heterogeneous Agents New Keynesian (THANK) models use simplifying assumptions regarding how inequality enters the economy and allow us to study the qualitative rather than the quantitative difference between heterogeneous agent New Keynesian models and the nested representative agent framework. These simplifications allow us to observe the inter-temporal trade-offs and study the distributional consequences of monetary and/fiscal policy in general equilibrium settings, without having to sacrifice the analytical tractability of the key results. As such, throughout this thesis we use these frameworks to study monetary and fiscal policy interactions.

In chapter one, we aim to better understand how the Heterogeneous Agent New Keynesian (HANK) economy differs from the nested Representative Agent New Keynesian (RANK) framework and how the policy mix is affected. We employ the analytically tractable HANK framework of Acharya et al. (2023) that combines the overlapping generations structure of Blanchard (1985) with the incomplete market model of Aiyagari (1994). We augment the model along two dimensions. First, we introduce a general debt structure and depart from the assumption that aggregate debt exists in zero net supply. An assumption that limits the models predictions regarding the longrun equilibrium as well as its dynamics. Next, we introduce “declining labour efficiencies“, as a proxy for the time spent in retirement, which results in richer inter- generational wealth inequality. We show that the parameter space that ensures a unique rational expectation equilibrium changes as we add more layers of heterogeneity. Finally, we argue that in the absence of aggregate risk, the fiscally- led policy mix (AF/PM) is preferred by a policy maker who values “equity“ more than “efficiency“ to the alternative monetary-led policy mix (AM/PF) in response to a transitionary (“ mit“) shock since it causes smaller deviations in inequality as well as in the MPC -out-of- cash on hand.

Next, in chapter two, we extend once more the framework of Acharya et al. (2023) to analyse optimal monetary and fiscal policy in a tractable heterogeneous agent New Keynesian (HANK) economy where overlapping generations of households wish to save for retirement and precautionary reasons. While monetary policy can affect the households’ ability to self-insure against shocks, fiscal policy has a greater impact on such behaviour both in steady-state and in response to aggregate shocks. A policy maker, even one wishing to minimize inequality solely, would, in steady state, provide insufficient government debt to enable households to save for retirement and accumulate precautionary savings. This is because they prefer to suppress interest rates below households’ rate of time preference, facilitating borrowing in the face of idiosyncratic shocks. The Ramsey policy maker faces a trade-off between “ equity“ and “ efficiency“ and due to the costs of servicing that debt with distortionary taxation will issue even less debt, driving equilibrium interest rates down further. We explore the relative efficacy of monetary and fiscal policy in responding to aggregate shocks in this environment, under different tax instruments.

Furthermore, in chapter three, we study optimal monetary policy in a tractable HANK environment with meaningful amount of government debt. The model admits both idiosyncratic and aggregate risk. The idiosyncratic shocks are uncorrelated between each other as well as with the aggregate shock. We assume that there exists a consolidated monetary- fiscal authority. The monetary authority pursues optimal (Ramsey) monetary policy whilst the fiscal authority follows a simple non- linear tax rule. Our aim is to provide a clear distinction between the notions of discontinuous labour market participation (DLMP) and infrequent asset market participation (IAMP), which are typically intertwined in the literature. In a HANK- DLMP model, constrained households are able to use assets to smooth their inter- temporal consumption. As such, the long run equilibrium as well as the model’s dynamics under optimal monetary policy are different from both the nested representative agent model and from the HANK- IAMP framework. We demonstrate that DLMP frictions are an important source of heterogeneity on their own merit and should not be overlooked. Finally, we find that despite the presence of imperfect risk sharing, the model delivers perfect self-insurance and the policy maker in our framework will not deviate from price stability in steady state (Woodford (2003)). This result is unaffected by the amount of outstanding government debt or the presence of direct redistribution.

Finally, throughout this thesis we investigate how household heterogeneity affects the conduct of monetary and fiscal policy. We explore the merits of different modelling assumptions regarding inequality and focus on how policy changes as we add more layers of heterogeneity. All models are calibrated for the US economy for the period 1985- 2021.

• Item Type: Thesis (PhD)
• Qualification Level: Doctoral
• Subjects: H Social Sciences > HB Economic Theory; H Social Sciences > HG Finance
• Colleges/Schools: College of Social Sciences > Adam Smith Business School
• Funder's Name: Economic and Social Research Council (ESRC)
• Supervisor's Name: Kirsanova, Professor Tatiana, Nolan, Professor Charles and Zhang, Dr. Ning
• Date of Award: 2024
• Depositing User: Theses Team
• Unique ID: glathesis:2024-84727
• Copyright: Copyright of this thesis is held by the author.
• Date Deposited: 02 Dec 2024 10:51
• Last Modified: 02 Dec 2024 10:57
• Thesis DOI: 10.5525/gla.thesis.84727
• URI: https://theses.gla.ac.uk/id/eprint/84727