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The related literature is very large. For early surveys of open and closed economy applications see Clarida, Gali and Gertler (1999) and Lane (2001). For current applications in policymaking institutions see the Federal Reserve Board’s SIGMA model and the IMF’s Global Economy Model (GEM).
We are separately pursuing the joint optimization of monetary and fiscal policy rules, but for for computational tractability this requires a simpler closed economy setup.
In emerging markets there is the additional problem that countercyclical policy may simply not be possible due to external or political constraints. Evidence and theoretical explanations are offered by Gavin and Perrotti (1997), Kaminsky, Reinhart and Vegh (2004), and Talvi and Vegh (2005). We do not think that these arguments apply to Chile in the recent period.
We adopt the convention throughout the paper that all nominal/real variables are written in upper/lower case letters. For real asset stocks, each nominal asset is deflated by the consumer price index of the currency of its denomination, so that real domestic bonds are bt = Bt/Pt and real internationally traded bonds are
We therefore keep the two lump-sum items separate. This also allows a better calibration of the baseline fiscal accounts.
Our notation for relative prices p uses the same superscripts as the respective quantities.
This assumption has become widely used. It prevents excessive short-term responsiveness of international trade to real exchange rate movements.
The target had previously been held at +1 for several years.
Incidentally, this target is a very good choice from the point of view of stabilizing the business cycle, because Chile’s net assets to GDP ratio is currently around 10%. This coincidence of flow and implied stock targets makes it unnecessary to intertemporally vary fiscal instruments in order to allow debt to reach the stock target.
Therefore, in this more general form of the rule, Chile’s recent stimulus package could be reinterpreted in terms of the rule as a more aggressive countercyclical behavior dtax > 1, rather than as a temporary reduction in the structural surplus target
The evidence is however for less smoothing in fiscal policy than in monetary policy. See Gali and Perotti (2003).
Such a variant of the rule would be essential in the case of permanent shocks that drive potential to a new level. In this paper all shocks are transitory.
For the latter two only the market clearing conditions for Chile are listed. RW conditions are symmetric.
This ratio has declined since the early 1990s.
Lump-sum taxes are all tax revenues that could not obviously be associated with the other three categories.
We set ϕP = 80, which corresponds to an average duration of price contracts in a Calvo-type model of between 4 and 5 quarters.
We also explored output gap and output growth terms, but these had only a small effect on welfare, with optimal coefficients near zero.
For a similar reason limits on nominal interest rate volatility are sometimes imposed in the optimal monetary policy literature.
Note that this is a different baseline from Figure 4, where dcop = ddebt = 0. This accounts for the differences in maximum welfare gains.
These are standard deviations of 100 times the log of the respective variable.
Using government investment spending alone as an instrument requires extreme variability in this variable. We were not able to obtain computational solutions for this case.