Controlling inflation with timid monetary-fiscal regime changes - PowerPoint PPT Presentation

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes → Multiplicity: Monetary and fiscal policy need to be balanced across regimes to have a unique equilibrium Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes → Multiplicity: Monetary and fiscal policy need to be balanced across regimes to have a unique equilibrium → New taxonomy: overall AM/PF vs overall switching policy mix Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes → Multiplicity: Monetary and fiscal policy need to be balanced across regimes to have a unique equilibrium → New taxonomy: overall AM/PF vs overall switching policy mix 3 These two regimes have different dynamic behaviour Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes → Multiplicity: Monetary and fiscal policy need to be balanced across regimes to have a unique equilibrium → New taxonomy: overall AM/PF vs overall switching policy mix 3 These two regimes have different dynamic behaviour → overall AM/PF mix ⇒ NO WEALTH EFFECTS Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 2 Importance of Coordination across regimes → Multiplicity: Monetary and fiscal policy need to be balanced across regimes to have a unique equilibrium → New taxonomy: overall AM/PF vs overall switching policy mix 3 These two regimes have different dynamic behaviour → overall AM/PF mix ⇒ NO WEALTH EFFECTS → overall switching mix ⇒ WEALTH EFFECTS Ascari, Florio and Gobbi MP and FP Interactions 7 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 4 Timidity trap (Krugman, 2014) Ascari, Florio and Gobbi MP and FP Interactions 8 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 4 Timidity trap (Krugman, 2014) → If only timid deviation into PM/AF ⇒ overall AM/PF ⇒ no wealth effects needed to reflate the economy Ascari, Florio and Gobbi MP and FP Interactions 8 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 4 Timidity trap (Krugman, 2014) → If only timid deviation into PM/AF ⇒ overall AM/PF ⇒ no wealth effects needed to reflate the economy 5 Application to ZLB and US data Ascari, Florio and Gobbi MP and FP Interactions 8 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 4 Timidity trap (Krugman, 2014) → If only timid deviation into PM/AF ⇒ overall AM/PF ⇒ no wealth effects needed to reflate the economy 5 Application to ZLB and US data → BVAR on US data for the recent ZLB period ⇒ IRFs: a deficit shock do not spur inflation Ascari, Florio and Gobbi MP and FP Interactions 8 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Results 4 Timidity trap (Krugman, 2014) → If only timid deviation into PM/AF ⇒ overall AM/PF ⇒ no wealth effects needed to reflate the economy 5 Application to ZLB and US data → BVAR on US data for the recent ZLB period ⇒ IRFs: a deficit shock do not spur inflation → ZLB + “timidity” in fiscal action ⇒ multiple equilibria ⇒ agents coordinating on the solution with no wealth effects Ascari, Florio and Gobbi MP and FP Interactions 8 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Related literature Regime changes in monetary policy Davig and Leeper (2007) ⇒ determinacy condition (LRTP) Liu, Waggoner and Zha (2009) ⇒ asymmetric expectation effects under the dovish and the hawkish monetary regime Bianchi (2013) ⇒ counterfactuals to show how equilibrium outcomes depend on agents’ beliefs about alternative dovish or hawkish monetary regimes Ascari, Florio and Gobbi MP and FP Interactions 9 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Related literature Regime changes in both monetary and fiscal policies Davig and Leeper (2006, 2011), Chung, Davig and Leeper (2007), Bianchi (2012), Bianchi and Ilut (2014) ⇒ Estimate Markov switching monetary and fiscal regimes for the U.S. and study the impact of policy shocks employing actual and counterfactual IRF Bhattarai, Lee and Park (2012): allow for indeterminacy in the estimate ` a la Lubik and Shorfheide (2004) ⇒ PM/PF in pre-Volcker, AM/PF in post-Volcker Bianchi and Melosi (2013, 2016) ⇒ study the link between inflation and fiscal imbalances Ascari, Florio and Gobbi MP and FP Interactions 10 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Related literature Technical literature on solving DSGE models with MS parameters Blake-Zampolli (2006), Davig-Leeper (2007), Farmer-Waggoner-Zha (2009, 2011), Cho (2014), Foerster (2013), Foester-Rubio Ramirez-Waggoner-Zha (2014) , Maih (2014), Barthelemy-Marx (2015) Ascari, Florio and Gobbi MP and FP Interactions 11 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Model: simple structure in nonlinear form � Y t − G R t � 1 = β E t , (Euler eq.) Y t + 1 − G Π t + 1 1 1 1 − θ = µθ ( 1 − α ) 1 − θ � � 1 − α Π θ − 1 φ t Y t t θ − 1 1 � � � � φ t + 1 Π θ 1 − α Π θ − 1 1 − θ + αβ E t , t + 1 t + 1 (NKPC) Y t � � Π θ − 1 φ t = Y t − G + αβ E t , t + 1 φ t + 1 b t = b t − 1 with b t = B t + G − τ t , . R t Π t P t (govt b.c.) Ascari, Florio and Gobbi MP and FP Interactions 12 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Fiscal and Monetary Policy Rules Fiscal policy � γ τ ( s t ) � b t − 1 e σ τ u τ , t τ t = τ ss b ss Monetary policy R t = R ss ( Π t ) γ π ( s t ) e σ r u m , t both depend on the underlying Markov process s t Ascari, Florio and Gobbi MP and FP Interactions 13 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Methodology We follow the method in FRWZ ⇒ regime-dependent recursive MSV solutions perturbed around the non-stochastic steady state Ascari, Florio and Gobbi MP and FP Interactions 14 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Methodology We follow the method in FRWZ ⇒ regime-dependent recursive MSV solutions perturbed around the non-stochastic steady state UCM ⇒ MSV solutions, no sunspots Ascari, Florio and Gobbi MP and FP Interactions 14 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Methodology We follow the method in FRWZ ⇒ regime-dependent recursive MSV solutions perturbed around the non-stochastic steady state UCM ⇒ MSV solutions, no sunspots System of quadratic equations ⇒ Groebner basis algorithm using Matlab’s Symbolic Toolbox to get all the solutions Ascari, Florio and Gobbi MP and FP Interactions 14 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Methodology We follow the method in FRWZ ⇒ regime-dependent recursive MSV solutions perturbed around the non-stochastic steady state UCM ⇒ MSV solutions, no sunspots System of quadratic equations ⇒ Groebner basis algorithm using Matlab’s Symbolic Toolbox to get all the solutions Stability: Mean Square Stable Ascari, Florio and Gobbi MP and FP Interactions 14 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Methodology We follow the method in FRWZ ⇒ regime-dependent recursive MSV solutions perturbed around the non-stochastic steady state UCM ⇒ MSV solutions, no sunspots System of quadratic equations ⇒ Groebner basis algorithm using Matlab’s Symbolic Toolbox to get all the solutions Stability: Mean Square Stable Unique solution when a single MSV MSS solution exists Appendix Method Ascari, Florio and Gobbi MP and FP Interactions 14 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under fixed coefficients Recasting Leeper (1991) in the context of our model monetary policy active ( AM ) when γ π > 1 and passive ( PM ) otherwise � � � 1 β − 1 τ ss fiscal policy passive ( PF ) when � < 1, i.e. b ss γ τ � � β γ τ > b ss τ ss ( 1 − β ) = 0.0196 and active ( AF ) otherwise (e.g. γ τ = 0) Ascari, Florio and Gobbi MP and FP Interactions 15 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under fixed coefficients Fixed coefficients 0.25 0.2 AM/PF uniqueness 0.15 PM/AF uniqueness 0.1 γ τ PM/PF multiplicity 0.05 AM/AF no stable solutions 0 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π Ascari, Florio and Gobbi MP and FP Interactions 16 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching We consider two regimes: s t = 1, 2 Contemporaneous switching in monetary and fiscal policy We focus on scenarios where one regime is AM/PF Reduce to a two dimensional graph: → fix a given (monetary or fiscal) policy in both regimes → fix a given regime (AM/PF) Ascari, Florio and Gobbi MP and FP Interactions 17 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The Monetary Policy Frontier (MPF) Given Passive Fiscal Policy (Davig and Leeper, 2007) Ascari, Florio and Gobbi MP and FP Interactions 18 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The Monetary Policy Frontier (MPF) Given Passive Fiscal Policy (Davig and Leeper, 2007) If fiscal policy stays passive in both regimes → back to Davig and Leeper’s Long-Run Taylor Principle → uniqueness allows timid deviations into PM → overall AM Ascari, Florio and Gobbi MP and FP Interactions 18 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The Fiscal Policy Frontier (FPF) Given Active Monetary Policy Ascari, Florio and Gobbi MP and FP Interactions 19 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The Fiscal Policy Frontier (FPF) Given Active Monetary Policy If monetary policy stays active in both regimes → Long-Run Fiscal Principle → uniqueness above the fiscal policy frontier → uniqueness allows timid deviations into AF → overall PF → MPF unaffected if LRFP holds (above FPF) Ascari, Florio and Gobbi MP and FP Interactions 19 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The Fiscal Policy Frontier (FPF) Proposition. The FPF and the long-run Fiscal Principle For any policy parameter combination, there always exists a particular solution such that in each regime: � ≡ ¯ h i = 1 � 1 − τ b γ τ , i h i ( γ τ , i ) and g π , i = 0, for i = 1, 2. β Then, this solution: (i) Is MSS, if above the Fiscal Policy Frontier (eq. (22)); (ii) Depends only on γ τ , i for i = 1, 2, and it is independent of the monetary policy coefficients; (iii) If MSS, it yields no wealth effects in both regimes because g π , i = 0, so it is a Ricardian solution. Ascari, Florio and Gobbi MP and FP Interactions 20 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Policies We want now consider a switching monetary policy: consider an AM regime 1 → for example ( γ π ,1 = 1.5 ) Ascari, Florio and Gobbi MP and FP Interactions 21 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Policies We want now consider a switching monetary policy: consider an AM regime 1 → for example ( γ π ,1 = 1.5 ) the central bank switches to PM in regime 2... Ascari, Florio and Gobbi MP and FP Interactions 21 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Policies We want now consider a switching monetary policy: consider an AM regime 1 → for example ( γ π ,1 = 1.5 ) the central bank switches to PM in regime 2... How should fiscal policy be in order to have uniqueness? → Need to distinguish two cases: timid vs. substantial switch Ascari, Florio and Gobbi MP and FP Interactions 21 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Timid Switching Monetary Policy Timid monetary deviation: ( γ π ,2 = 0.97 ) (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.97) 0.25 Timid deviations in monetary B 0.2 policy within the MPF: LRTP holds ⇒ Overall AM 0.15 0.1 γ τ ,1 0.05 0 C −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 22 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Timid Switching Monetary Policy Timid monetary deviation: ( γ π ,2 = 0.97 ) (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.97) 0.25 Timid deviations in monetary B 0.2 policy within the MPF: LRTP holds ⇒ Overall AM 0.15 → uniqueness preserved above 0.1 γ τ ,1 FPF ⇒ timid deviations into AF ⇒ overall PF 0.05 0 C −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 22 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Timid Switching Monetary Policy Timid monetary deviation: ( γ π ,2 = 0.97 ) (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.97) 0.25 Timid deviations in monetary B 0.2 policy within the MPF: LRTP holds ⇒ Overall AM 0.15 → uniqueness preserved above 0.1 γ τ ,1 FPF ⇒ timid deviations into AF ⇒ overall PF 0.05 → Overall AM/PF Mix 0 C −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 22 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Timid Switching Monetary Policy Timid monetary deviation: ( γ π ,2 = 0.97 ) (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.97) 0.25 Timid deviations in monetary B 0.2 policy within the MPF: LRTP holds ⇒ Overall AM 0.15 → uniqueness preserved above 0.1 γ τ ,1 FPF ⇒ timid deviations into AF ⇒ overall PF 0.05 → Overall AM/PF Mix 0 C → one Ricardian solution ⇒ −0.05 no wealth effects −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 22 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Monetary Policy Substantial monetary deviation: ( γ π ,2 = 0.90 ) Substantial deviations in (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 monetary policy outside the MPF ⇒ Switching monetary B 1 0.2 policy 0.15 0.1 γ τ ,1 0.05 0 D −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 23 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Monetary Policy Substantial monetary deviation: ( γ π ,2 = 0.90 ) Substantial deviations in (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 monetary policy outside the MPF ⇒ Switching monetary B 1 0.2 policy → Uniqueness if substantial 0.15 deviation in fiscal policy: 0.1 Switching fiscal policy γ τ ,1 0.05 0 D −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 23 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Monetary Policy Substantial monetary deviation: ( γ π ,2 = 0.90 ) Substantial deviations in (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 monetary policy outside the MPF ⇒ Switching monetary B 1 0.2 policy → Uniqueness if substantial 0.15 deviation in fiscal policy: 0.1 Switching fiscal policy γ τ ,1 → multiplicity instead if 0.05 overall passive FP (MPF - LRTP unsatisfied) 0 D −0.05 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 Ascari, Florio and Gobbi MP and FP Interactions 23 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Switching Monetary Policy Substantial monetary deviation: ( γ π ,2 = 0.90 ) Substantial deviations in (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 monetary policy outside the MPF ⇒ Switching monetary B 1 0.2 policy → Uniqueness if substantial 0.15 deviation in fiscal policy: 0.1 Switching fiscal policy γ τ ,1 → multiplicity instead if 0.05 overall passive FP (MPF - LRTP unsatisfied) 0 D → Overall Switching Policies −0.05 Mix: above the straight line: one fiscal unbacking −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 solution ⇒ wealth effects Ascari, Florio and Gobbi MP and FP Interactions 23 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Ascari, Florio and Gobbi MP and FP Interactions 24 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall AM: monetary policy combination inside Monetary Policy Frontier ⇒ only timid deviations into PM are allowed Ascari, Florio and Gobbi MP and FP Interactions 24 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall AM: monetary policy combination inside Monetary Policy Frontier ⇒ only timid deviations into PM are allowed Overall PF: fiscal policy combination inside Fiscal Policy Frontier ⇒ only timid deviations into AF are allowed Ascari, Florio and Gobbi MP and FP Interactions 24 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall AM: monetary policy combination inside Monetary Policy Frontier ⇒ only timid deviations into PM are allowed Overall PF: fiscal policy combination inside Fiscal Policy Frontier ⇒ only timid deviations into AF are allowed Overall AM/PF Mix: overall AM + overall PF ⇒ Ricardian solution : no wealth effects in both regimes Ascari, Florio and Gobbi MP and FP Interactions 24 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Ascari, Florio and Gobbi MP and FP Interactions 25 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall switching monetary policy: monetary policy combinations outside Monetary Policy Frontier ⇒ substantial deviations in PM Ascari, Florio and Gobbi MP and FP Interactions 25 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall switching monetary policy: monetary policy combinations outside Monetary Policy Frontier ⇒ substantial deviations in PM Overall switching fiscal policy: fiscal policy combinations outside Fiscal Policy Frontier ⇒ substantial deviations into AF Ascari, Florio and Gobbi MP and FP Interactions 25 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination: towards a new taxonomy Given an AM/PF regime 1, monetary and fiscal policies need to be overall balanced to obtain a unique stable equilibrium: Overall switching monetary policy: monetary policy combinations outside Monetary Policy Frontier ⇒ substantial deviations in PM Overall switching fiscal policy: fiscal policy combinations outside Fiscal Policy Frontier ⇒ substantial deviations into AF Overall SWITCHING Mix: overall switching monetary policy + overall switching fiscal policy ⇒ Non-Ricardian solution : wealth effects in both regimes Ascari, Florio and Gobbi MP and FP Interactions 25 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB IRFs to a tax shock under MS and fixed coefficients Regime 1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) Regime 2: ( γ π ,2 , γ τ ,2 ) = (0.97, 0.00) Regime 1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) Regime 2: ( γ π ,2 , γ τ ,2 ) = (0.90, −0.05) 10 10 10 10 5 5 5 5 Y Y Y Y 0 0 0 0 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 10 40 10 40 Π 5 Π 20 Π 5 Π 20 0 0 0 0 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 10 40 10 40 R 5 R 20 R 5 R 20 0 0 0 0 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 10 10 10 10 b 5 b 5 b 5 b 5 0 0 0 0 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 0 0 0 τ τ τ τ −5 −5 −5 −5 −10 −10 −10 −10 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 0 10 20 30 40 Overall AM/PF Mix Overall Switching Mix Blue solid lines: MS; Red dashed lines: fixed coefficients Ascari, Florio and Gobbi MP and FP Interactions 26 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB The importance of coordination (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.97) (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 0.25 B 1 B 0.2 0.2 0.15 0.15 0.1 0.1 γ τ ,1 γ τ ,1 0.05 0.05 0 C 0 D −0.05 −0.05 −0.1 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 γ τ ,2 Modest deviations Substantial deviations original taxonomy of little use Ascari, Florio and Gobbi MP and FP Interactions 27 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB What determines uniqueness? How to define timid vs. substantial deviations? Ascari, Florio and Gobbi MP and FP Interactions 28 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under fixed coefficients Fixed coefficients 0.25 0.2 AM/PF uniqueness 0.15 PM/AF uniqueness 0.1 γ τ PM/PF multiplicity 0.05 AM/AF no stable solutions 0 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π Ascari, Florio and Gobbi MP and FP Interactions 29 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching “Timid” deviations: relaxing Leeper’s conditions (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 0.2 0.15 0.1 γ τ ,2 0.05 0 A B B 1 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 30 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions (p 11 ,p 22 ) = (1.00, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 0.2 0.15 0.1 γ τ ,2 0.05 (1 − β ) b τ 0 ¯ γ τ , 2 −0.05 −0.1 0.8 0.9 ¯ γ π , 2 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 31 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions If regime 1 is AM/PF and absorbing, uniqueness: Upper-right region � � γ 2, τ > b ss β 1 − √ p 22 τ ss � 1 − β √ p 22 � � 1 − √ p 22 � γ 2, π > √ p 22 − λ Ascari, Florio and Gobbi MP and FP Interactions 32 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions If regime 1 is AM/PF and absorbing, uniqueness: Upper-right region � � γ 2, τ > b ss PF: γ τ > b ss β 1 − τ ss ( 1 − β ) √ p 22 τ ss � 1 − β √ p 22 � � 1 − √ p 22 � γ 2, π > √ p 22 − AM: γ π > 1 λ Ascari, Florio and Gobbi MP and FP Interactions 32 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions If regime 1 is AM/PF and absorbing, uniqueness: Upper-right region � � γ 2, τ > b ss β PF: γ τ > b ss 1 − τ ss ( 1 − β ) √ p 22 τ ss � 1 − β √ p 22 � � 1 − √ p 22 � γ 2, π > √ p 22 − AM: γ π > 1 λ → timid deviations from AM and PF still grant uniqueness → Same intuition as for Davig & Leeper for the LRTP Ascari, Florio and Gobbi MP and FP Interactions 32 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions If regime 1 is AM/PF and absorbing, uniqueness: Upper-right region � � γ 2, τ > b ss PF: γ τ > b ss β τ ss ( 1 − β ) 1 − √ p 22 τ ss � 1 − β √ p 22 � � 1 − √ p 22 � γ 2, π > √ p 22 − AM: γ π > 1 λ → timid deviations from AM and PF still grant uniqueness → Same intuition as for Davig & Leeper for the LRTP → deviations can be larger the smaller p 22 Ascari, Florio and Gobbi MP and FP Interactions 32 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Uniqueness under regime switching: absorbing case “Timid” deviations: relaxing Leeper’s conditions Lower-left region � � γ 2, τ < b ss β 1 − √ p 22 τ ss � 1 − β √ p 22 � � 1 − √ p 22 � γ 2, π < √ p 22 − λ → monetary policy needs to deviate substantially from AM → fiscal policy needs to deviate substantially from PF → substantial and coordinated deviations to get uniqueness Ascari, Florio and Gobbi MP and FP Interactions 33 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 0.15 0.1 γ τ ,2 0.05 A B 0 B 1 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 0.05 A B 0 B 1 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 → Overall AM/PF Mix 0.05 A B 0 B 1 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 → Overall AM/PF Mix 0.05 → No wealth effects A B 0 B 1 −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 → Overall AM/PF Mix 0.05 → No wealth effects A B 0 B 1 → Substantial deviations B 1 from AM and PF −0.05 −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 → Overall AM/PF Mix 0.05 → No wealth effects A B 0 B 1 → Substantial deviations B 1 from AM and PF −0.05 → Overall Switching Mix −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Dynamic response of the model Does the two solutions B and B 1 exhibit different dynamics? (p 11 ,p 22 ) = (0.95, 0.95); Regime1: ( γ π ,1 , γ τ ,1 ) = (1.50, 0.20) 0.25 Main Intuition: A New Taxonomy 0.2 B → Timid deviations from 0.15 AM and PF 0.1 γ τ ,2 → Overall AM/PF Mix 0.05 → No wealth effects A B 0 B 1 → Substantial deviations B 1 from AM and PF −0.05 → Overall Switching Mix −0.1 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 γ π ,2 → Wealth effects Ascari, Florio and Gobbi MP and FP Interactions 34 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Policy Implications Several Implications 1 Establish conditions for dynamics to exhibit wealth effects with MS changes Ascari, Florio and Gobbi MP and FP Interactions 35 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Policy Implications Several Implications 1 Establish conditions for dynamics to exhibit wealth effects with MS changes 2 Timidity Trap (Krugman, 2014) Ascari, Florio and Gobbi MP and FP Interactions 35 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Policy Implications Several Implications 1 Establish conditions for dynamics to exhibit wealth effects with MS changes 2 Timidity Trap (Krugman, 2014) 3 Expectation effects are asymmetric (e.g., Liu-Waggoner-Zha, 2009) Ascari, Florio and Gobbi MP and FP Interactions 35 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Policy Implications Several Implications 1 Establish conditions for dynamics to exhibit wealth effects with MS changes 2 Timidity Trap (Krugman, 2014) 3 Expectation effects are asymmetric (e.g., Liu-Waggoner-Zha, 2009) 4 Wealth effects and FTPL is not always at work if agents attach a positive probability of moving towards active fiscal policy (e.g., Chung-Davig-Leeper, 2007) MSS vs boundedness → overall policy stance matters → estimation and multiple equilibria Ascari, Florio and Gobbi MP and FP Interactions 35 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB Policy Implications Several Implications 1 Establish conditions for dynamics to exhibit wealth effects with MS changes 2 Timidity Trap (Krugman, 2014) 3 Expectation effects are asymmetric (e.g., Liu-Waggoner-Zha, 2009) 4 Wealth effects and FTPL is not always at work if agents attach a positive probability of moving towards active fiscal policy (e.g., Chung-Davig-Leeper, 2007) MSS vs boundedness → overall policy stance matters → estimation and multiple equilibria 5 Regime persistence is key (Bianchi and Melosi, 2013) → define “timid deviations”, MPF and FPF, and type of regimes Ascari, Florio and Gobbi MP and FP Interactions 35 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB (p 11 ,p 22 ) = (0.95, 0.95); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) (p 11 ,p 22 ) = (0.95, 0.80); Monetary policy: ( γ π ,1 , γ π ,2 ) = (1.50, 0.90) 0.25 0.25 0.2 0.2 0.15 0.15 0.1 0.1 γ τ ,1 γ τ ,1 0.05 0.05 0 0 −0.05 −0.05 −0.1 −0.1 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 −0.1 −0.05 0 0.05 0.1 0.15 0.2 0.25 γ τ ,2 γ τ ,2 p 22 = 0.95 p 22 = 0.80 Ascari, Florio and Gobbi MP and FP Interactions 36 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence Assume expected AM/PF and Trend inflation = 0% now ZLB p 11 = (0.95); ( γ π ,1 , γ τ ,1 , γ π ,2 ) = (1.50, 0.20, 0.00) 0.2 0.15 0.1 γ τ ,2 0.05 0 −0.05 −0.1 0.7 0.75 0.8 0.85 0.9 0.95 1 p 22 Ascari, Florio and Gobbi MP and FP Interactions 37 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence Assume expected AM/PF and Trend inflation = 0% now ZLB p 11 = (0.95); ( γ π ,1 , γ τ ,1 , γ π ,2 ) = (1.50, 0.20, 0.00) 0.2 If ZLB is short-lasting ⇒ multiplicity irrespective 0.15 of FP 0.1 γ τ ,2 0.05 0 −0.05 −0.1 0.7 0.75 0.8 0.85 0.9 0.95 1 p 22 Ascari, Florio and Gobbi MP and FP Interactions 37 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence Assume expected AM/PF and Trend inflation = 0% now ZLB p 11 = (0.95); ( γ π ,1 , γ τ ,1 , γ π ,2 ) = (1.50, 0.20, 0.00) 0.2 If ZLB is short-lasting ⇒ multiplicity irrespective 0.15 of FP 0.1 If ZLB long-lived ⇒ γ τ ,2 Uniqueness unattainable 0.05 if PF 0 −0.05 −0.1 0.7 0.75 0.8 0.85 0.9 0.95 1 p 22 Ascari, Florio and Gobbi MP and FP Interactions 37 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence Assume expected AM/PF and Trend inflation = 0% now ZLB p 11 = (0.95); ( γ π ,1 , γ τ ,1 , γ π ,2 ) = (1.50, 0.20, 0.00) 0.2 If ZLB is short-lasting ⇒ multiplicity irrespective 0.15 of FP 0.1 If ZLB long-lived ⇒ γ τ ,2 Uniqueness unattainable 0.05 if PF 0 The more ZLB −0.05 short-lived, the more active should be FP −0.1 0.7 0.75 0.8 0.85 0.9 0.95 1 p 22 Ascari, Florio and Gobbi MP and FP Interactions 37 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence Assume expected AM/PF and Trend inflation = 0% now ZLB p 11 = (0.95); ( γ π ,1 , γ τ ,1 , γ π ,2 ) = (1.50, 0.20, 0.00) 0.2 If ZLB is short-lasting ⇒ multiplicity irrespective 0.15 of FP 0.1 If ZLB long-lived ⇒ γ τ ,2 Uniqueness unattainable 0.05 if PF 0 The more ZLB −0.05 short-lived, the more active should be FP −0.1 0.7 0.75 0.8 0.85 0.9 0.95 1 p 22 Switching regime ⇒ wealth effects Ascari, Florio and Gobbi MP and FP Interactions 37 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence IRFs to a deficit shock from a BVAR on US data 2008q4 - 2015q4 Output and inflation do not move, debt increases Ascari, Florio and Gobbi MP and FP Interactions 38 / 39

Introduction Model and methodology Monetary/Fiscal Frontiers Dynamics Uniqueness Policy Implications ZLB ZLB: Matching theory and evidence IRFs to a deficit shock from a BVAR on US data 2008q4 - 2015q4 Output and inflation do not move, debt increases Consistent with PM/AF regime in a overall AM/PF mix ⇒ timid AF and indeterminate equilibrium Ascari, Florio and Gobbi MP and FP Interactions 38 / 39