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Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time

Author

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  • Bernd Hayo

    (University of Marburg)

  • Britta Niehof

    (University of Marburg)

Abstract

To analyse the interdependence between monetary and fiscal policy during a financial crisis, we develop an open-economy DSGE model with monetary and fiscal policy as well as financial markets in a continuous-time framework based on stochastic differential equations. Monetary policy is modelled using both a standard and a modified Taylor rule and fiscal policy is modelled as either expansionary or austere. In addition, we differentiate between open economies and monetary union members. We find evidence that the modified Taylor rule notably reduces the likelihood that the financial market crisis affects the real economy. But if we assume that households are averse with respect to outstanding government debt, we find that a combination of expansionary monetary policy and austere fiscal policy provides better stabilisation of both domestic and foreign economies in terms of both output and inflation. In the case of a monetary union, we find that stabilisation of output in the country where the financial shock originates is no longer as easy and, in terms of prices, there is now deflation in the country where the crisis originated and a positive inflation rate in the other country.

Suggested Citation

  • Bernd Hayo & Britta Niehof, 2014. "Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time," MAGKS Papers on Economics 201455, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    • Handle: RePEc:mar:magkse:201455
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    3. Shobande Olatunji Abdul & Shodipe Oladimeji Tomiwa, 2019. "New Keynesian Liquidity Trap and Conventional Fiscal Stance: An Estimated DSGE Model," Economics and Business, Sciendo, vol. 33(1), pages 152-169, January.

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    More about this item

    Keywords

    New Keynesian Models; Financial Crisis; Dynamic Stochastic General Equilibrium Models; Continuous Time Model; Fiscal Policy; Monetary Policy;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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