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Title: Three essays on the interaction between monetary and fiscal policy in commodity-rich economies
Author: Troug, Haytem
ISNI:       0000 0004 7654 8494
Awarding Body: University of Exeter
Current Institution: University of Exeter
Date of Award: 2019
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Assuming prior separability in preferences between private consumption and government consumption can produce stagnant estimates of the response of macroeconomic variables to government consumption shocks. These estimates conflict with some of the empirical findings in the literature. To overcome this discrepancy, and make DSGE models compatible with empirical models, we extend an otherwise standard New Keynesian model to allow for the presence of non-separable government consumption in the utility function, which is financed by means of lump-sum taxes. This introduction will affect the entire structure of New Keynesian models, and will make it deviate from the standard case. In the first chapter, we conduct our analysis in a closed economy framework. We demonstrate how the introduction of government consumption in a non-separable form affects the transmission of monetary policy. We find that when government consumption has a crowding-in effect on private consumption, it will have a crowding-out effect on monetary policy. However, when government consumption has a crowding out effect on private consumption, it will have a crowding-in effect on monetary policy. This is a result of the effect of introducing non-separable government consumption on the slope of the IS curve. In this regard, when government consumption is introduced as a complement to private consumption in the model, macroeconomic variables become less responsive to changes in interest rates and vice versa. We also show how monetary policy should optimally respond to demand and supply shocks when government consumption is a complement to private consumption in one scenario, and once it is a substitute to private consumption in the other. If monetary policy fails to keep track of developments in government consumption, this will cause inflationary (deflationary) pressure when government consumption is a complement (substitute) to private consumption. In the second chapter, we extend our analysis to a small open economy framework. Extending the model to a small open economy case complicates the problem for monetary policy to the extent that the authorities must additionally take into account how the exchange rate affects other macroeconomic variables. The other extension that we add to the canonical small open economy model is that we also model the rest of the world economy in our framework. This will allow us to trace the spillover effects of supply and demand shocks in the foreign economy on the domestic economy. In the open-economy case, the degree of openness will minimise the deviation of the slope of the IS curve from the standard case both in the complementarity case and the substitutability case. Moreover, the degree of openness minimises the crowding-out (-in) effect of government consumption towards monetary policy when the former is a complement (substitute) to private consumption. We also find that the fiscal multiplier is also minimised by the degree of openness of the economy, in comparison to the closed-economy version of the model. We additionally find that the size of the fiscal multiplier is adversely affected by the response of monetary policy and the flexibility of the exchange rate, which is in line with the findings of the existing literature. Moreover, we show that, in the case of the spillover effect of external shocks, the amount of exchange rate volatility will determine how much the domestic economy will be affected by external shocks. This will result in different effects of domestic and foreign government consumption on domestic private consumption, both in the substitutability and complementarity case, which contradicts the findings of some of the existing literature. In the third chapter, we adopt a small open economy model for a commodity-rich country to quantitatively study the triggers of business cycles in different commodity-rich economies, and to highlight the existence of heterogeneity among commodity-rich economies. We extend the model used in the second chapter by adding some features to our model to make it more relevant for a commodity-rich economy. Our model allows for a quadruple role for commodities. First, the domestic government collects the windfalls of selling commodities to the rest of the world. Second, commodities are consumed by households both in the domestic economy and the foreign economy. Third, firms both in the domestic economy and the foreign economy use commodities as an input in their production. Lastly, the domestic economy is affected by the second-round effect of an increase in commodity prices in the form of high foreign inflation and low world demand. Moreover, the prices of commodities are endogenously determined in the model, and are affected by developments in the rest of the world economy. The primary behavioural parameters that the chapter focuses on are the elasticity of substitution between government consumption and private consumption and the response of government consumption to fluctuations in commodity prices. The former parameter is an indicator of the efficiency of government consumption and its effect on private consumption (crowding-in versus crowding-out). The other parameter captures the behaviour and the stance of fiscal policy during booms and busts of commodity prices, along with the size of the commodity windfalls in the government's revenue. We feed the model with a variety of shocks that were previously proposed in the literature. The estimations of the model show that oil-rich economies are more vulnerable to external shocks than their commodity-rich counterparts. This is mainly the result of the size of commodity windfalls in the economy, as the shares of oil revenues are significantly higher than the revenues of other commodities, as a ratio of output. The results also show that there exists a policy crowding out effect of fiscal policy to monetary policy in oil-rich economies.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available