This paper examines the performance and robustness of simple monetary policy rules in models with learning agents subject to: (1) permanent or occasionally non-Ricardian fiscal policy; and/or (2) the presence of long-term government debt. My analysis indicates that the "global" response of the fiscal policymaker to debt determines the optimal monetary policy response. When fiscal policy is globally passive or globally active the optimal monetary policy rule typically features time-invariant coefficients with high inflation reaction coefficients in globally passive models and interest rate pegs in globally active models. In cases where fiscal policy features balanced or strong switching between active and fiscal policy stances, the optimal monetary policy rule features switching coefficients. These results extend to models with adaptive learning, including a hidden Markov model of learning never seen before in the literature.
Standard New Keynesian models predict implausibly large and favorable responses of inflation and output to expansionary forward guidance on interest rates. We find that the introduction of permanent or recurring active fiscal policy dampens the response of output and inflation to forward guidance in the New Keynesian model. Moreover, the presence of regime-switching policy introduces expectational effects that cause forward guidance to be less stimulative in our regime-switching model's active money, passive fiscal policy regime. Finally, the introduction of long-term debt affects the magnitude of the stimulus resulting from forward guidance in models with active fiscal policy.
This paper addresses the relationship between determinacy and E-stability in an abstract class of Markov-switching DSGE models with lagged endogenous variables. In this very general setting, we prove that a set of determinacy conditions from Cho (2016) and Cho (2018) imply the E-stability of the unique solution when agents condition their expectations on contemporaneous variables and use one-step-ahead decision rules. By considering a general class of models with lagged endogenous variables, this paper extends McCallum (2007) to a wide range of useful DSGE models that feature time-variation in model coefficients.
Maturity, Determinacy and E-Stability in Models of Regime Switching Fiscal and Monetary Policy
This paper explores issues of determinacy and E-stability in a New Keynesian model with switching fiscal and monetary policy. In this paper, we consider three categories of results. First, we show that the maturity structure of government debt matters for determinacy and the existence of stable equilibria in the switching model, which is not true in the analogous fixed coefficient model. Second, we show that determinacy typically but not always implies E-stability when agents do not observe contemporaneous observable variables. Third, we find that the link between E-stability under infinite horizon learning and E-stability under Euler equation learning is weaker in the presence of regime switches than in fixed regime models.
Works in Progress
Fiscal Policy Regimes and Central Bank Balance Sheets
Adaptive Learning in Hidden Markov Models
Heterogenous Learning and the Value of Intergenerational Knowledge Transfers (with Tristan Nighswander)