Optimal Simple Rules for the Conduct of Monetary and Fiscal Policy

We develop a simple model for studying the impact of monetary and fiscal policies on aggregate demand, at the business cycle frequencies. We focus on two questions principally. First, what are the key properties of the joint optimal simple rules governing the conduct of the systematic components of monetary and fiscal policy? Second, following Blanchard (1985) we construct an index of fiscal stance to disentangle the ‘expenditure’ and wealth effects of fiscal policy. We find that underpinning the so-called ‘Taylor principle’ is a fiscal policy maker giving full force to automatic stabilizers. We also find that the Mundellian assignment of policy instruments may have attractive properties.