Monetary and fiscal policy, the exchange rate and foreign wealth

Abstract

The theory of macroeconomic policy is now in a difficult position. After the demise of the old keynesian orthodoxy, dissatisfaction has grown with monetarist ideas, too. This thesis aims to contribute to the search for a new framework for macroeconomic policy. Throughout the thesis great emphasis is put on two key ideas. The first is that both monetary and fiscal policy should be used in a well designed policy package. Such a policy package should consist of rules, on the grounds that simple rules, more easy to understand and monitor in the eyes of the private sector, would enhance the credibility of the government's pre-commitment. The second idea is that foreign wealth accumulation, operating through cumulating current account imbalances, plays a key role in the determination of the open economy macroeconomic equilibrium and its stability. Therefore open economy models should include wealth effects and the current account. Furthermore, policy evaluation should take into account, among other things, the Implications of alternative rules on foreign wealth. We shall consider policy design both in a small individual country and in the broader context of policy coordination.