I. Research Question
What monetary policy should be adopted in order to maintain price stability when the government uses the supply side fiscal policies?
II. Brief Introduction
Monetary and fiscal policies today majorly focus on the demand stimulus by incentivizing consumption in order to increase the aggregate demand to achieve higher output. Even though consumption contributes to the major output, purely focusing on the demand side typically only provides a short run solution to economic growth. Supply-side economy, developed in the 1970s, focused on the production, and the promotion of the aggregate supply. Even though supply side policies are usually distinguished from demand side policies, some are actually overlapped. Cutting income …show more content…
Krugman (1998) suggested that a drop in future productivity trapped Japan in ZLB. Fernández-Villaverde, Guerrón-Quintana and Rubio-Ramírez (2011) used a two-period New Keynesian model to study the supply side policies at the ZLB, and conclude that supply side policies play a role in fighting situations when the economy sticks at the zero-lower bound. Taylor (1996) used the Taylor rule and Fisher equation to show that if the potential real GDP grows but the Fed does not take into account, price will be unstable and the Fed would have to adjust policies to make sure negative effects of GDP being temporary. Clarida, Gali and Gertler (1999) used the New Keynesian model to conclude that keeping the nominal interest rate constant perfectly adopt any shocks to potential output because increase in productivity will also improve future income and thereby push the demand to close the output gap. Nevertheless, the outcome of supply side policies only comes in the long run and the effect is unpredictable. Lucas (1990) showed that tax changes might alter the long run growth rate and the long run equilibrium levels, even though the effect might be small, because the cost and benefit of tax cut might be close to each other. Other strategies such as investment in R&D will have strong uncertainty in increasing the potential output. Measuring the potential output has …show more content…
More specifically, government spending will be composed of two parts: spending for the supply side (S) and other spendings (G). The spending of S will increase the next period’s productivity and potential output (probably with uncertainty). I am not sure which model I am going to base, maybe the New Keynesian model, or the DSGE model, or something else. However, the model will eventually address the question: how will the central bank respond when supply policy is adopted and there is a potential to increase future productivity and natural
What monetary policy should be adopted in order to maintain price stability when the government uses the supply side fiscal policies?
II. Brief Introduction
Monetary and fiscal policies today majorly focus on the demand stimulus by incentivizing consumption in order to increase the aggregate demand to achieve higher output. Even though consumption contributes to the major output, purely focusing on the demand side typically only provides a short run solution to economic growth. Supply-side economy, developed in the 1970s, focused on the production, and the promotion of the aggregate supply. Even though supply side policies are usually distinguished from demand side policies, some are actually overlapped. Cutting income …show more content…
Krugman (1998) suggested that a drop in future productivity trapped Japan in ZLB. Fernández-Villaverde, Guerrón-Quintana and Rubio-Ramírez (2011) used a two-period New Keynesian model to study the supply side policies at the ZLB, and conclude that supply side policies play a role in fighting situations when the economy sticks at the zero-lower bound. Taylor (1996) used the Taylor rule and Fisher equation to show that if the potential real GDP grows but the Fed does not take into account, price will be unstable and the Fed would have to adjust policies to make sure negative effects of GDP being temporary. Clarida, Gali and Gertler (1999) used the New Keynesian model to conclude that keeping the nominal interest rate constant perfectly adopt any shocks to potential output because increase in productivity will also improve future income and thereby push the demand to close the output gap. Nevertheless, the outcome of supply side policies only comes in the long run and the effect is unpredictable. Lucas (1990) showed that tax changes might alter the long run growth rate and the long run equilibrium levels, even though the effect might be small, because the cost and benefit of tax cut might be close to each other. Other strategies such as investment in R&D will have strong uncertainty in increasing the potential output. Measuring the potential output has …show more content…
More specifically, government spending will be composed of two parts: spending for the supply side (S) and other spendings (G). The spending of S will increase the next period’s productivity and potential output (probably with uncertainty). I am not sure which model I am going to base, maybe the New Keynesian model, or the DSGE model, or something else. However, the model will eventually address the question: how will the central bank respond when supply policy is adopted and there is a potential to increase future productivity and natural