Tight and Loose, and Red and Blue: A 'Dance' of Macro Policies in the US

Abstract

Using optimising policy framework, we build and estimate a small-scale DSGE model of the US, and tell the story of monetary and fiscal policy interactions in 1955-2018. We find that fiscal policy is important to identify shifts in monetary policy preferences, and it is shaped by the political color. We use this model to analyse the episode of zero lower bound on interest rate in 2008-15. We find that the bound constrained monetary policy, explain some observed irregularities in macroeconomic data, and demonstrate that a change to price level targeting could have generated a powerful lift-off from the constraint.