The relative influence of monetary and fiscal policy: some results for the U.S.A.

This thesis examines the relative power of monetary and fiscal policy. The seminal paper by Friedman and Meiselman on this topic re-opened the debate about it. Using a reduced form approach their results suggested that monetary policy was the more important of the two but this approach has several inadequacies and instead a structural model should be used to examine this issue.iOne of the most contentious issues in the debate is the specification of the monetary transmission; in particular Monetarists view the consumption and money demand decisions to be strongly inter-related. In this thesis the aim is to specify the monetary transmission mechanism in a structural model in a way that allows this to be tested in the context of a model, examining the effects of monetary and fiscal policy. This was carried out paying special attention to the specification of the price expectations process and care was taken to estimate the model in a systematic way that yielded as much information as possible about the dynamics of the model.It was found that the consumption/money demand model performed well thus; supporting the Monetarist description of the monetary-transmission mechanism. The model estimates were compared with those of a model estimated by Moroney and Mason which was constructed in a more ad hoc fashion but with a similar aim in mind. The comparison highlighted the importance of correctly specifying and estimating a model.Since the model specified in this thesis is non-linear it had to be simulated to examine its properties. Despite the fact that the Monetarist consumption/money demand model worked well the simulations showed that contrary to the Monetarist view monetary policy has little effect on the economy whereas fiscal policy has a strong effect.