Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0501 Title: Optimal Monetary Policy When Lump-Sum Taxes Are Unavailable: A Reconsideration of the Outcomes under Commitment and Discretion Author-Name: Martin Ellison Author-Email: m.ellison@warwick.ac.uk Author-Name: Neil Rankin Author-Email: n.rankin@warwick.ac.uk Abstract: We re-examine optimal monetary policy when lump-sum taxes are unavailable. Under commitment, we show that, with alternative utility functions to that considered in Nicolini’s related analysis, the direction of the incentive to cheat may depend on the initial level of government debt, with low debt creating an incentive towards surprise deflation, but high debt the reverse. Under discretion, we show that the economy will not necessarily tend to the Friedman Rule, as Obstfeld found. Instead it may tend to the critical debt level at which there is no cheating incentive under commitment, and inflation and could well be positive here. Creation-Date: 2005-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0501.pdf File-Format: Application/pdf Classification-JEL: E52, E61. Keywords: Time consistency; optimal inflation-tax smoothing; discretion; commitment; Friedman Rule. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0502 Title: Uninsured Risks, Loan Contracts and the Declining Equity Premium Author-Name: Sanjay Banerjee Author-Name: Parantap Basu Abstract: Using a two period model with moral hazard and uninsured risk, we argue that the decline in equity premium from its historically high level is due to a gradual elimination of barriers to universal banking. The loan contracts set up by financial intermediaries became more complete in nature with the advent of universal banking in the 90s following the Gramm-Leach-Billy Act. Hence, it is the nature of the loan contracts, not just the borrowing constraint and uninsured risks that is more fundamental in explaining the size of the equity premium. Creation-Date: 2005-08 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0502.pdf File-Format: Application/pdf Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0503 Title: Measuring Fiscal Sustainability Author-Name: Vito Polito Author-Name: Mike Wickens Abstract: We propose an index of the fiscal stance that is convenient for practical use. It is based on a finite time horizon, not on an infinite time horizon like most tests. As it employs VAR analysis it is simple to compute and easily automated. We also show how it is possible to analyse a change of policy within a VAR framework. We use this methodology to examine the effect on fiscal sustainability of a change in policy. We then conduct an empirical examination of the fiscal stances of the US, the UK and Germany over the last 25 or more years, and we carry out a counter-factual analysis of the likely consequences for fiscal sustainability of using a Taylor rule to set monetary policy over this period. Among our findings are that the recent fiscal stances of all three countries are not sustainable, and that using a Taylor rule in the past would have improved the fiscal stances of the US and UK, but not that of Germany. Creation-Date: 2005-06 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0503.pdf File-Format: Application/pdf Classification-JEL: C22, C53, E62, E63. Keywords: Budget deficits; government debt; fiscal sustainability; VAR analysis; economic policy. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0504 Title: Computing Second-Order-Accurate Solutions for Rational Expectation Models Using Linear Solution Methods Author-Name: Giovanni Lombardo Author-Email: Giovanni.Lombardo@ecb.int Author-Name: Alan Sutherland Author-Email: ajs10@st-andrews.ac.uk Abstract: This paper shows how to compute a second-order accurate solution of a non-linear rational expectation model using algorithms developed for the solution of linear rational expectation models. This result is a state-space representation for the realized values of the variables of the model. This state-space representation can easily be used to compute impulse responses as well as conditional and unconditional forecasts. Creation-Date: 2005-03 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0504.pdf File-Format: Application/pdf Classification-JEL: E63, E0. Keywords: Second-order approximation; solution method for rational expectation models. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0505 Title: Expansionary Effects of the Welfare State in a Small Open Economy Author-Name: Hassan Molana Author-Name: Catia Montagna Author-Email: c.montagna@dundee.ac.uk Abstract: We examine the relationship between welfare state policies and economic performance in a small open economy with (i) free trade in final goods and international capital mobility, and (ii) aggregate increasing returns to scale. Contrary to the conventional wisdom, we find that a retrenchment of welfare programmes is not an inevitable consequence of economic integration. Instead, by improving the exploitation of aggregate scale economies, social expenditure policies and international openness complement each other in facilitating an improvement in economic performance that can sustain a more generous welfare protection. Creation-Date: 2005-10 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0505.pdf File-Format: Application/pdf Classification-JEL: E6, F1, F4, H3, J5. Keywords: Welfare state; circular causation; international trade; capital mobility. Template-Type: ReDIF-Paper 1.0 Handle: RePEc:san:cdmacp:0506 Title: Fiscal Policy as a Stabilisation Device for an Open Economy Inside or Outside EMU Author-Name: Campbell Leith Author-Email: c.b.leith@socsci.gla.ac.uk Author-Name: Simon Wren-Lewis Abstract: Extending Gali and Monacelli (2004), we build an N-country open economy model, where each economy is subject to sticky wages and prices and, potentially, has access to sales and income taxes as well as government spending as fiscal instruments. We examine an economy either as a small open economy under flexible exchange rates or as a member of a monetary union. In a small open economy when all three fiscal instruments are freely available, we show analytically that the impact of technology and mark-up shocks can be completely eliminated, whether policy acts with discretion or commitment. However, once any one of these fiscal instruments is excluded as a stabilisation tool, costs can emerge. Using simulations, we find that the useful fiscal instrument in this case (in the sense of reducing the welfare costs of the shock) is either income taxes or sales taxes. In contrast, having government spending as an instrument contributes very little. In the case of mark-up shocks tax instruments which can offset the impact of the shock directly are highly effective, while other fiscal instruments are less useful. The results for an individual member of a monetary union facing an idiosyncratic technology shock (where monetary policy in the union does not respond) are very different. First, even with all fiscal instruments freely available, the technology shock will incur welfare costs. Government spending is potentially useful as a stabilisation device, because it can act as a partial substitute for monetary policy. Finally, sales taxes are more effective than income taxes at reducing the costs of a technology shock under monetary union. If all three taxes are available, they can reduce the impact of the technology shock on the union member by around a half, compared to the case where fiscal policy is not used. Finally we consider the robustness of these results to two extensions. Firstly, introducing government debt, such that policy makers take account of the debt consequences of using fiscal instruments as stabilisation devices, and, secondly, introducing implementation lags in the use of fiscal instruments. We find that the need for debt sustainability has very limited impact on the use of fiscal instruments for stabilisation purposes, while implementation lags can reduce, but not eliminate, the gains from fiscal stabilisation. Creation-Date: 2005-11 File-URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0506.pdf File-Format: Application/pdf Classification-JEL: E32, E60, F41.