DP13432 Monetary and Fiscal Policy when People have Finite Lives

Author(s): Roger E A Farmer, Pawel Zabczyk
Publication Date: January 2019
Date Revised: January 2022
Keyword(s): FTPL, Indeterminacy, Monetary and Fiscal Policy, monetary policy, OLG model
JEL(s): E31, E52, E58, H62
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13432

For at least three decades, the New-Keynesian representative agent model has been the preferred vehicle for analyzing the interaction of â??fiscal and monetary policy with the behavior of private agents in markets. We argue that the Overlapping Generations (OLG) model is an attractive alternative and that a number of features of real world economies arise naturally in a long-lived version of this model when it is calibrated to the U.S. income profile. These features include 1) the transmission of monetary shocks to real quantities, 2) excess volatility of real asset prices and 3) the existence of decade long periods with negative real interest rates. We provide an example of a sixty-two generation OLG model where all of these features arise in a dynamically effcient competitive equilibrium with complete markets in which money has positive value. Our results hold even in the case in which both monetary and fiscal policies are active in the sense of Leeper (1991).