Stabilization Policies Which Reverse Stagflation in a Short Run Macromodel

Abstract

This paper explores monetary-fiscal policies which reverse stagflation, that is, policies which reduce both the inflation rate and the unemployment rate. The analysis will be carried out within a conventional short-run, closed, deterministic macromodel, such as the one constructed by Stein [10]. The main theoretical innovation pursued here is to incorporate two additional fiscal instruments into the model: excise and sales (indirect) taxes, and employer contributions to social insurance (referred to as a labor tax).' Along with direct taxes (personal income taxes and employee contributions to social insurance), the model thus contains three tax rates. We are, therefore, able to analyze not only the impact of changes in these tax rates but also the effects of changes in the tax structure. The analysis focuses only on short-run effects throughout; that is, we analyze only the short-run impact of monetary-fiscal actions on the inflation rate and the unemployment rate. The length of the period we have in mind is one year, which period length will be reflected in the econometric estimates we employ. There will be no attempt here to analyze the effects of policy actions on a steady-state values.2 The main conclusions of this study are easily summarized. It is well known that changes in money supply and/or government spending cannot by themselves offset stagflation in the short-run, nor can they in the model presented here.3 However, appropriate changes in the money supply and/or government spending in concert with certain types of tax rate changes