Modern Perspectives on

Stabilisation Policies

Jordi Galí

CREI, UPF, CEPR and NBER

Norges Bank

April 27, 2005

Two Keynesian Themes Revisited

The Social Waste of Recessions

The Effectiveness of Fiscal Policy as a Stabilisation Tool

A New Keynesian Perspective on the Welfare Costs of Fluctuations Joint work with M. Gertler and D. López-

Salido

Two Views on Economic Fluctuations

Neoclassical

Keynesian

The Gap

tt tgap mrs mpn

0tgap Efficiency Condition:

Common Distortions:

Decomposition:

0tgap

( )p wt t tgap

A Parametric Specification

t t tmpn y n t t tmrs c n

( )t t t t tgap c n y n

[ ( )]

( ) ( )

p nt t t

t t t t

t t t t

p mc

p w y n

y n w p

( )

( ) ( )

wt t t t

t t t t

w p mrs

w p c n

Evidence on the U.S. Gap: 1960-2004

The Gap and the Wage Markup

Gap Fluctuations and Welfare

2

t t tU U gap gap

ttgap gap gap

where

gap–

gap+

Utility

gapt

? U+

? U–

– μ

^

^ 0

Implications

The Cost of Postwar Recessions

Non-Ricardian Consumers and the Effectiveness of Fiscal Policy Joint work with D. López-Salido and J.

Vallés

Recent Evidence (BP, FM):

Contradicts predictions of RBC and NK models

0t

t

dC

dG 1t

t

dY

dG

The Effects of Government Spending Shocks

The GLV Model NK Model with a Fraction of Non-Ricardian

Households

NR Budget Constraint

Conditions for Positive Consumption Response Large fraction of NR Households Sufficient Price Stickiness Limited Short Run Increase in Taxes

satisfied under plausible calibrations

t t t tC W N T

The Fiscal Multiplier, Welfare, and the Gap Under what conditions will an increase in

(wasteful) government spending raise welfare ?

sufficient underutilization of resources ( ) multiplier sufficiently greater than one

1 exp 1tt

t

dYgap

dG

0tgap

Has Fiscal Policy Been Stabilising in Practice? Joint work with R. Perotti

Estimation of Fiscal Policy Rules

EMU, EU3, OECD5 Sample period: 1980-2002

* *0 1 1 1t x t t b t d t td E x b d u

Changes in Discretionary Fiscal Policy

1980-1991 1992-2002 Change

Cross-Country Averages

EMU 0.25 -0.23 -0.48

EU3 -0.60 -0.91 -0.31

OECD5 -0.12 -0.63 -0.51

Panel Estimates

EMU 0.17 -0.08 -0.25

EU3 -0.09 -0.76 -0.67

OECD5 -0.14 -0.72 -0.58

Estimates of Output Gap Coefficient:

increasingly countercyclical discretionary fiscal policies

Fiscal Policy in Recessions

Change in Structural Deficit / Change in Output Gap

Early 80s Early 90s Early 2000s

EMU 0.33 0.27 -0.24

EU3 0.35 -0.64 -0.73

OECD5 0.20 -0.69 -0.52

increasingly aggressive use of fiscal policy to fight recessions

Some Thoughts on a Quote

“We Are All Keynesians Now”

Richard Nixon, 1972