Essays in Monetary and Fiscal Policy

When it comes to monetary and, especially, fiscal policy, standard focus relates to topics such as changes in policy regimes, general tax levels, fiscal expenditures, and uncertainties therein. These are broad abstractions from reality, which more often deals with policies that are more subtle than these. These seemingly small policy changes possess the potential to have dramatic and lasting impacts on the economy. My dissertation considers some of these smaller policies, their coordination with monetary policy, and their potential impact on the economy in general. Included in these policies are the removal of small currency denominations from circulation, the indexation of the federal income tax code, and the use of differing measures of inflation in policy considerations. My findings suggest that some policies considered to be important may not be, while other policies deemed insignificant can have dramatic consequences. For example, policy makers have been increasingly concerned with the future of the monetary system’s foundation: currency. While some have focused on larger denominations, for decades a debate has focused on the effects of price-rounding if the smallest denominations are eliminated. In my first chapter, I deviate from the bulk of the literature, which typically considers case-studies with empirical simulations and data manipulation, and evaluate a multiple household, deterministic model with endogenous currency production. My findings suggest that the elimination of the smallest unit of currency has a “nickel-and-dime” effect on the economy, regardless of the rounding policy. This model is constructed and calibrated to emulate a “worst-case scenario”, but it is also robust to the empirical results in the literature as well as the empirical results in this work. In the second chapter, I consider a standard DSGE model with a labor income tax code derived from household income levels, finding that subtle alterations in this tax code can cause substantial changes in model dynamics. Specifically, I find that indexing the federal income tax code for inflation in the 1980s had a significant impact on the economy. My results are parallel to those of the recent monetary/fiscal policy coordination literature without considering government debt and to those of the Great Moderation literature without changing monetary policy. This suggests that the reductions in volatility seen in the data were not merely unilateral changes by monetary policy makers, but a combination of single-handed movements on both sides. Thus, even if this combination of policy changes was not sufficient to usher in the period of tranquility seen from the late-1980s through the mid-2000s, this study suggests that they were necessary. Finally, using a two-sector New Keynesian model with sector-specific levels of price stickiness, I explore the impact of changing the monetary authority’s infla- tion target from a narrow measure to a broad measure while fiscal policy continues to index its tax codes and transfer payment systems to the narrow measure. I find that a monetary policy adjustment like this can have a large impact on the level and variation of real fiscal debt, but the magnitude and direction of the im- pact is conditional on the coordinated stance of the policy makers. However, this switch in regimes unconditionally causes most standard deviations to increase. This matches the trends seen in latest time-varying parameter empirical mod- els since 2000, when the Federal Reserve began using forecasts of the personal consumption expenditures (PCE) chain-type price index instead of the consumer price index (CPI)