Report

Pareto Improving Fiscal and Monetary Policies: Samuelson in the New Keynesian Model

Abstract: This paper explores the positive and normative consequences of government bond issuances in a New Keynesian model with heterogeneous agents, focusing on how the stock of government bonds affects the cross-sectional allocation of resources in the spirit of Samuelson (1958). We characterize the Pareto optimal levels of government bonds and the associated monetary policy adjustments that should accompany Pareto-improving bond issuances. The paper introduces a simple phase diagram to analyze the global equilibrium dynamics of inflation, interest rates, and labor earnings in response to changes in the stock of government debt. The framework also provides a tractable tool to explore the use of fiscal policy to escape the Effective Lower Bound (ELB) on nominal interest rates and the resolution of the “forward guidance puzzle.” A common theme throughout is that following the monetary policy guidance from the standard Ricardian framework leads to excess fluctuations in income and inflation.

Keywords: Inflation; Ricardian Equivalence; Heterogeneous agents; Government debt;

JEL Classification: E60; E40; E30;

https://doi.org/10.21034/sr.646

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2023-06-16

Number: 646