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Designing Monetary And Fiscal Policy Rules In A New Keynesian Model With Rule-of-thumb Consumers

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This paper develops a small New Keynesian model augmented with a steady state level of public debt and a share of Rule-Of-Thumb Consumers (ROTC henceforth) as in Gali'et al. (2004; 2007). The paper focuses on the consequences for the design of monetary and fiscal rules, of the bifurcation generated by the presence of ROTC on the demand side of the economy, in the absence of Ricardian equivalence. The authors find that, when fiscal policy follows a balanced budget rule, the amount of ROTC determines whether an active and/or a passive monetary policy in the sense of Leeper (1991) guarantee determinacy. When short run public debt assets are introduced, the amount of ROTC determines whether equilibrium determinacy requires a mix of active (passive) monetary policy and a passive (active) fiscal policy or a mix where policies are either active or passive.