Fiscal and Monetary Policy Rules In an Unstable Economy

This paper examines the implications of different monetary and fiscal policy rules in an economy characterized by Harrodian instability. We show that (i) a monetary rule along Taylor lines can be stabilizing for low debt ratios but becomes de-stabilizing if the debt ratio exceeds a certain threshold, (ii) a `Keynesian\u27 fiscal policy rule can stabilize the economy at full employment, (iii) a fiscal `austerity\u27 rule that links fiscal parameters to deviations from a target debt ratio fails to adjust the `warranted\u27 to the `natural\u27 growth rate and destabilizes the warranted path, (iv) instability may arise from a combination of fiscal and monetary policy rules which separately would stabilize the system, and (v) austerity rules can in some circumstances enhance the stabilizing effects of monetary policy