The dynamic effects of monetary and fiscal policies : a theoretical simulation approach

Abstract

This thesis is concerned with the familjar question regarding the relative efficacy of monetary and fiscal policies. In the light of recent theoretical developments, our analysis is focused upon several mac ro-dynamic models whose general structure is fairly representative of contemporary stock-adjustment models. In analyzing such dynamic models, the usual approach is to rely on standard analytical techniques to derive comparativestatic effects and stability conditions. It is suggested that, as iv a useful addition to that strategy, one might adopt a more explicitly dynamic approach and examine the time paths taken by the system, with the use of simulation. In macroeconomics, the term "simulation" is most often associated with econometric models . This study suggests an alternative view, one which regards simulation as a numerical but theoretically oriented supplement to the traditional analytical approach. Specifically, such a theoretical simulation approach ·' would require the construction and manipulation of models whose structures are highly general in nature, and whose parameters, although plausible, do not pertain to any individual real-world economy but rather reflect conditions underlying a wide variety of systems. Our results suggest that this approach can indeed be a useful supplement to formal analysis. With its aid, we are able to determine the probable directions (and sometimes the likely magnitudes) of a number of comparative-static effects which are ambiguous analytically. Stability characteristics also become much more apparent. In particular, it is shown that monetary measures designed to maintain a constant growth rate of the nominal stock of money are very prone to instability, as are those which peg the real stock of money at a fixed level. The experiments carried out also suggest that theoretical simulation can help to provide further insights into the system's dynamic adjustments which take place between the two end-point equilibria. In the process, the roles of several dynamic mechanisms are highlighted. These include two automatic stabilizers, namely fncome and inflation ta xes ; the interest income on government bonds; and the multiplier -accelerator mechanism. The experiments point strongly toward the intermediate view that bond-financed fiscal actions do not have a significant, positive effect on real income in the long run, but do have some effects in real income in the short run and on nominal income in the long run. Show more