Optimal Monetary and Fiscal Policy with Limited Asset Market Participation
IMF Working Papers, July 1, 2009
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Bibliographic details
- Authors: Sven Jari Stehn
- Published: July 1, 2009
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451872842.001
Summary
- The paper characterises the jointly optimal monetary and fiscal stabilisation policy in a new Keynesian model that allows for consumers who lacking access to asset markets consume their disposable income each period.
- With full asset market participation, the optimal policy relies entirely on the interest rate to stabilise cost-push shocks and government expenditure is not changed.
- When asset market participation is limited, there is a case for fiscal stabilisation policy: active use of public spending raises aggregate welfare by enabling a more balanced distribution of the stabilisation burden across asset-holding and non-asset-holding consumers.
- The optimal response of government expenditure is sensitive to the financing scheme and whether the policymaker has access to a targeted transfer that can directly redistribute resources between consumers.
Model features and key mechanisms
- New Keynesian framework with two consumer types: asset-holding consumers and consumers lacking access to asset markets who consume their disposable income each period.
- Cost-push shocks are a central shock considered for stabilisation policy.
- Fiscal policy (government expenditure and targeted transfers) can reallocate stabilisation burdens between consumer types when asset market participation is limited.
- The financing scheme for government expenditure and the availability of targeted transfers materially affect the optimal fiscal response.
Main findings
- Under full asset market participation:
- Optimal stabilisation relies entirely on the interest rate.
- Government expenditure is unchanged in response to cost-push shocks.
- Under limited asset market participation:
- There is a welfare-improving role for active fiscal stabilisation through public spending.
- Public spending can raise aggregate welfare by more evenly distributing stabilisation costs across consumer types.
- The optimal path for government expenditure depends on the chosen financing scheme and on whether targeted transfers are available.
Policy implications and recommendations
- Monetary policy should be the primary stabilisation tool when asset market participation is widespread.
- Where asset market participation is limited, policymakers should consider deploying fiscal stabilisation tools in addition to monetary policy to improve aggregate welfare.
- Design of fiscal responses must account for:
- The financing scheme used for government expenditure.
- The presence or absence of targeted transfers that can directly reallocate resources between asset-holding and non-asset-holding consumers.
- Targeted transfers can change the optimal mix of monetary and fiscal actions by providing direct redistribution channels.
Key statistics and publication identifiers
- Pages: 34
- Volume: 2009
- Issue: 137
- Series: Working Paper No. 2009/137
- DOI: https://doi.org/10.5089/9781451872842.001
- Stock No: WPIEA2009137
- ISBN: 9781451872842
- ISSN: 1018-5941
- Author: Sven Jari Stehn
- Date: July 1, 2009
Optimal Monetary and Fiscal Policy with Limited Asset Market Participation — Sven Jari Stehn (IMF Working Paper No. 2009/137), accessed via the canonical page.
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