Fiscal Policy in the New Neoclassical Synthesis

We analytically derive the cyclical effects of fiscal policy shocks in a New Neoclassical Synthesis model. Price stickiness has the consequence that a rise in government demand affects labor demand, while at the same time the usual wealth effect boosts labor supply. The strength of the demand effect...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2003-12, Vol.35 (6), p.911-929
Main Authors: Linnemann, Ludger, Schabert, Andreas
Format: Article
Language:English
Subjects:
Aggregate demand
Analysis
Bank credit
Business cycles
Central banks
Economic impact
Economic models
Economic shock
Expenditures, Public
Finance
Fiscal policy
Inflation
Inflation rates
Interest rates
Keynesianism
Labor demand
Labor supply
Labour demand
Labour supply
Modeling
Monetary policy
Nominal interest rates
Public expenditures
Sticky prices
Studies
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Summary:We analytically derive the cyclical effects of fiscal policy shocks in a New Neoclassical Synthesis model. Price stickiness has the consequence that a rise in government demand affects labor demand, while at the same time the usual wealth effect boosts labor supply. The strength of the demand effect depends on the response of the real interest rate governed by the monetary policy regime. When the central bank controls money growth, fiscal expansions are deflationary and might even be contractionary, whereas output, wages, and, inflation can increase when the rise in the real interest rate is dampened by an interest rate rule. However, price stickiness alone is not sufficient to explain a rise in consumption as predicted by Keynesian theory.
ISSN:0022-2879
1538-4616
1538-4616
DOI:10.1353/mcb.2003.0045