The Roles of Monetary, Financial and Fiscal Policy with Rational Expectations

The setup of the paper is as follows: Section I presents a fairly standard, small deterministic macromodel with a number of classical features. All markets clear instantaneously, there is no money illusion, and perfect foresight rules. The effects of monetary, financial, and fiscal policies in this model are analyzed. A number of nonneutrality propositions are stated. The drawback of this model is that it is ad hoc in the sense that private behavioral relationships have not been derived from explicit optimizing behavior. Section II, therefore, summarizes the results of some studies on debt neutrality and monetary superneutrality in a "fully rational" overlapping generations model. This leads to the conclusion that the ad hoc model of Section I is not a bad parable for such fully rational models. Section III abandons the assumption of universal instantaneous Wairasian equilibrium and considers the consequences of price and wage stickiness for the scope for stabilization policy; stochastic models are analyzed here, which also permits the consideration of some of the interesting issues associated with incomplete information