Budgetary policies in a DSGE model with finite horizons

This paper presents a dynamic stochastic general equilibrium model with nominal rigidities, capital accumulation and finite horizons. Our New Keynesian framework exhibits intergenerational wealth effects and is intended to investigate the macroeconomic implications of fiscal policy, which is specified by either a debt-based tax rule or a balanced-budget rule allowing for temporary deficits. The model predicts that fiscal expansions generate a trade-off in output dynamics between short-term gains and medium-term losses. It is shown that the effects of fiscal shocks crucially depend upon the conduct of monetary policy. Simulation analysis suggests that balanced-budget requirements enhance the determinacy properties of feedback interest rate rules by guaranteeing inflation stabilization.

► This paper presents a New Keynesian with wealth effects to study the implications of fiscal policy.
► We study the effects of fiscal expansions under a debt-based tax rule and a balanced-budget rule.
► The model predicts that fiscal expansions generate a trade-off in output dynamics between short-term gains and medium-term losses.
► The effects of fiscal shocks depend upon the conduct monetary and fiscal policy mix.
► Balanced-budget rules enhance the determinacy properties of feedback interest rate rules and stabilize inflation.