Does the more accommodative monetary policy lead to stronger fiscal policy effects?

Why is it interesting?
This comparison highlights the importance of monetary policy accommodation for fiscal policy effects. It compares the impact of government spending by looking at different central bank reaction functions - model-specific estimated rule from Cogan et al. (2010) and the much more accommodative user-specified rule (as in Bernanke et al. (1999)) that responds only to lagged values of inflation and the interest rate and does not react to GDP.

What to do on the MMB?
  • Models: US_CCTW10
  • Policy Rules: User specified rule (set 0.9 for interest_t-1 and 0.11 for infation_t-1), Model specific rule
  • Shocks: Fiscal Policy Shock
  • Variables: Inflation, Interest, Output

What is interesting?
The increase in government purchases induces much stronger effects on aggregate GDP under the user-specified rule. Even in the absence of rule-of-thumb consumers, the GDP upshot exceeds unity in the first 4 quarters. The much more accommodative monetary policy regime allows for a Keynesian multiplier effect. Private consumption rises due to higher government consumption. This crowding-in effect outweighs the negative wealth effect coming from higher anticipated future taxes. The comparison emphasizes the importance of fiscal-monetary interactions for the effects of discretionary fiscal policy.

Reference: Afanasyeva E., Kuete M., Wieland V. & Yoo J. (2016)
Edited by Milivojevic L.