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Discussion Papers – Discussion Paper
Series 1: Economic Studies
No 21/2006

Monetary and fiscal policy interactions in a
New Keynesian model with capital
accumulation and non-Ricardian consumers
Campbell Leith
(University of Glasgow)
Leopold von Thadden
(European Central Bank)

Abstract
This paper develops a small New Keynesian model with capital accumulation and
government debt dynamics. The paper discusses the design of simple monetary and fiscal
policy rules consistent with determinate equilibrium dynamics in the absence of Ricardian
equivalence. Under this assumption, government debt turns into a relevant state variable
which needs to be accounted for in the analysis of equilibrium dynamics. The key analytical
finding is that without explicit reference to the level of government debt it is not possible to
infer how strongly the monetary and fiscal instruments should be used to ensure determinate
equilibrium dynamics. Specifically, we identify in our model discontinuities associated with
threshold values of steady-state debt, leading to qualitative changes in the local determinacy
requirements. These features extend the logic of Leeper (1991) to an environment in which
fiscal policy is non-neutral. Naturally, this non-neutrality increases the importance of fiscal
aspects for the design of policy rules consistent with determinate dynamics.
JEL classification numbers: E52, E63.

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ISBN 3–86558–167–6 (Printversion)
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Editorial Board: Heinz Herrmann
Thilo Liebig
Karl-Heinz Tödter

Discussion Papers – Discussion Paper
Series 1: Economic Studies
No 21/2006

Monetary and fiscal policy interactions in a
New Keynesian model with capital
accumulation and non-Ricardian consumers
Campbell Leith
(University of Glasgow)
Leopold von Thadden
(European Central Bank)

http://www.bis.org/cbhub/indexm17.htm#monetary

http://www.bis.org/cbhub/index.htm

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