Economic Modelling 30 (2013) 643–662

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Economic Modelling

journal homepage: www.elsevier.com/locate/ecmod

The effects of fiscal spending shocks on the performance of simple monetary policy rules
Ali K. Malik ⁎
Karachi School for Business and Leadership (KSBL), Bahadurabad, National Stadium Road, Karachi 74800, Pakistan

a r t i c l e i n f o
Article history:
Accepted 26 August 2012
JEL classification:
E50
E52
E58
Keywords:
Fiscal policy
Monetary policy
Inflation targeting
Impulse response analysis
Macroeconomic variables

1. Introduction a b s t r a c t
We examine the effects of fiscal shocks on the performance of alternative monetary policy rules in a small dynamic general equilibrium framework. We explicitly consider the interaction between fiscal and monetary policy rules which may be present in the real world. We use a simple specification for the fiscal policy rule and various specifications for the (simple) monetary policy rule. Our analysis suggests that some form of flex- ible inflation targeting regime would perform well in response to fiscal shocks compared to other forms of policy regimes.
© 2012 Elsevier B.V. All rights reserved.

monetary policy has developed largely in isolation. The terminology
‘fiscal theory of the price level’ does however correspond to some ear- Monetary policy rules have come under extensive examination in the literature on monetary policy in the recent years. Simple mone- tary policy rules appear to be more robust across a wide range of models compared to the optimal rules and tend to perform better em- pirically as well, see Taylor (1999a). Taylor (1993, 1999b) finds that his simple policy rule (known as the ‘Taylor’ rule) performs remark- ably well in empirically (approximating) the monetary policy of the
Federal