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
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