Spanish Economic Review

, Volume 9, Issue 1, pp 39–57 | Cite as

Monetary Rules and Deficit Shocks

  • Barbara Annicchiarico
  • Alessandro Piergallini
Regular Article


Modern theory on interest rate rules is based on the representative agent framework with infinite-horizon consumers, thereby ignoring redistributions of the fiscal burden across generations due to deficit shocks. We show how the ‘Taylor principle’ relies on this restrictive assumption. In a dynamic New Keynesian general equilibrium model with overlapping generations, the existence of a unique stable rational expectations equilibrium may also occur under a passive monetary policy. However, active monetary policy is still required to stabilize the economy in response to fiscal shocks.


Interest rate rules Nominal rigidities Deficit shocks Wealth effects 

JEL Classification

E52 E58 E63 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Ascari G, Rankin N (2006) Perpetual youth and endogenous labour supply: a problem and a possible solution. J Macroecon (forthcoming)Google Scholar
  2. Benigno P, Woodford M (2003) Optimal targeting rules for monetary and fiscal policy. NBER Macroeconomics Annual Conference, April, 4–5Google Scholar
  3. Blanchard OJ (1985) Debt, deficits, and finite horizons. J Polit Econ 93:223–247CrossRefGoogle Scholar
  4. Bullard J, Mitra M (2002) Learning about monetary policy rules. J. Monetary Econ 49:1105–1129CrossRefGoogle Scholar
  5. Calvo GA (1983) Staggered prices in a utility maximizing framework. J. Monet Econ 12:383–398CrossRefGoogle Scholar
  6. Clarida R, Galí J, Gertler M (1998) Monetary policy rules in practice: some international evidence. Eur Econ Rev 42:1033–1067CrossRefGoogle Scholar
  7. Clarida R, Galí J, Gertler M (1999) The science of monetary policy: a new Keynesian perspective. J Econ Lit 37:1661–1707Google Scholar
  8. Clarida R, Galí J, Gertler M (2000) Monetary rules and macroeconomic stability: evidence and some theory. Q J Econ 115:147–180CrossRefGoogle Scholar
  9. Galí J (2003) New perspectives on monetary policy, inflation, and the business cycle. In Advances in economic theory, vol 3. by: Dewatripont, M Hansen, L Turnovsky S (eds) Cambridge University Press, Cambridge, pp 151–197Google Scholar
  10. Galí J, López-Salido D, Vallés J (2003) Understanding the effects of government spending on consumption. ECB Working Paper Series 339Google Scholar
  11. Galí J, López-Salido D, Vallés J (2004) Rule-of-thumb consumers and the design of interest rate rules. J Money Credit Bank 36:739–764CrossRefGoogle Scholar
  12. Gerlach S, Schnabel G (2000) The Taylor rule and interest rates in the EMU Area. Econ Lett 67:165–171CrossRefGoogle Scholar
  13. Goodfriend M, King RG (1997) The new classical synthesis and the role of monetary policy. NBER Macroecon Annu 12:231–283CrossRefGoogle Scholar
  14. Judd LP, Rudebusch GD (1998) Taylor’s rule and the Fed: 1970–1997. Fed Reserve Bank San Francisco Econ Rev 3:3–16Google Scholar
  15. Orphanides A (2001) Monetary policy rules based on real-time data. Am Econ Rev 91:964–985CrossRefGoogle Scholar
  16. Orphanides A (2003) Historical monetary policy analysis and the taylor rule. J Monet Econ 50: 983–1022CrossRefGoogle Scholar
  17. McCallum BT (1999) Issues in the design of monetary policy rules. In Taylor, JB Woodford M (eds) Handbook of macroeconomics. North Holland, AmsterdamGoogle Scholar
  18. McCallum BT (2003) Multiple-solution indeterminacies in monetary policy analysis. J Monet Econ 50:1153–1175CrossRefGoogle Scholar
  19. Sargent TJ, Wallace N (1975) ‘Rational’ expectations, the optimal monetary instrument, and the optimal money supply rule. J Polit Econ 83:241–254CrossRefGoogle Scholar
  20. Sauer S, Sturm JE (2006) Using Taylor rules to understand ECB monetary policy. German Econ Rev (forthcoming)Google Scholar
  21. Schmitt-Grohé S, Uribe M (2000) Price level determinacy and monetary policy under a balanced-budget requirement. J Monet Econ 45:211–246CrossRefGoogle Scholar
  22. Taylor JB (1993) Discretion versus policy rules in practice. Carnegie-Rochester conf Series Public Policy 39:195–214CrossRefGoogle Scholar
  23. Taylor JB (1999a) Monetary policy rules. The University of Chicago Press, ChicagoGoogle Scholar
  24. Taylor JB (1999b). A historical analysis of monetary policy rules. In: Taylor JB (eds). Monetary policy rules. University of Chicago Press, ChicagoGoogle Scholar
  25. Woodford M (2001) The Taylor rule and optimal monetary policy. Am Econ Rev 91:232–237CrossRefGoogle Scholar
  26. Woodford M (2003) Interest and prices. Princeton University Press, Princeton and OxfordGoogle Scholar
  27. Yaari ME (1965) Uncertain lifetime, life insurance, and the theory of the consumer. Rev Econ Stud 32:137–150CrossRefGoogle Scholar

Copyright information

© Springer-Verlag 2006

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of Rome ‘Tor Vergata’RomaItaly

Personalised recommendations