Essays on macroeconomic effects of fiscal policy rules

Economic and Monetary Union can be characterised as a complicated set of legislation and institutions governing monetary and fiscal responsibilities. The measures of fiscal responsibility are to be guided by the Stability and Growth Pact, which sets rules for fiscal policy and makes a discretionary fiscal policy virtually impossible. To analyse the effects of the fiscal and monetary policy mix, we modified the New Keynesian framework to allow for supply effects of fiscal policy. We show that defining a supply-side channel for fiscal policy using an endogenous output gap changes the stabilising properties of monetary policy rules. The stability conditions are affected by fiscal policy, so that the dichotomy between active (passive) monetary policy and passive (active) fiscal policy as stabilising regimes does not hold, and it is possible to have an active monetary - active fiscal policy regime consistent with dynamical stability of the economy. We show that, if we take supply-side effects into ac-count, we get more persistent inflation and output reactions. We also show that the dichotomy does not hold for a variety of different fiscal policy rules based on government debt and budget deficit, using the tax smoothing hypothesis and formulating the tax rules as difference equations. The debt rule with active monetary policy results in indeterminacy, while the deficit rule produces a determinate solution with active monetary policy, even with active fiscal policy. The combination of fiscal requirements in a rule results in cyclical responses to shocks. The amplitude of the cycle is larger with more weight on debt than on deficit. Combining optimised monetary policy with fiscal policy rules means that, under a discretionary monetary policy, the fiscal policy regime affects the size of the inflation bias. We also show that commitment to an optimal monetary policy not only corrects the inflation bias but also increases the persistence of output reactions. With fiscal policy rules based on the deficit we can retain the tax smoothing hypothesis also in a sticky price model.

Dynamics of inflation expectations in the euro area

The present study examines empirically the inflation dynamics of the euro area. The focus of the analysis is on the role of expectations in the inflation process. In six articles we relax rationality assumption and proxy expectations directly using OECD forecasts or Consensus Economics survey data. In the first four articles we estimate alternative Phillips curve specifications and find evidence that inflation cannot instantaneously adjust to changes in expectations. A possible departure of expectations from rationality seems not to be powerful enough to totally explain the persistence of euro area inflation in the New Keynesian framework. When expectations are measured directly, the purely forward-looking New Keynesian Phillips curve is outperformed by the hybrid Phillips curve with an additional lagged inflation term and the New Classical Phillips curve with a lagged expectations term. The results suggest that the euro area inflation process has become more forward-looking in the recent years of low and stable inflation. Moreover, in low inflation countries, the inflation dynamics have been more forward-looking already since the late 1970s. We find evidence of substantial heterogeneity of inflation dynamics across the euro area countries. Real time data analysis suggests that in the euro area real time information matters most in the expectations term in the Phillips curve and that the balance of expectations formation is more forward- than backward-looking. Vector autoregressive (VAR) models of actual inflation, inflation expectations and the output gap are estimated in the last two articles.The VAR analysis indicates that inflation expectations, which are relatively persistent, have a significant effect on output. However,expectations seem to react to changes in both output and actual inflation, especially in the medium term. Overall, this study suggests that expectations play a central role in inflation dynamics, which should be taken into account in conducting monetary policy.

Non-Gaussian Cosmological Perturbations from Hybrid Inflation and Preheating

This thesis consists of four research papers and an introduction providing some background. The structure in the universe is generally considered to originate from quantum fluctuations in the very early universe. The standard lore of cosmology states that the primordial perturbations are almost scale-invariant, adiabatic, and Gaussian. A snapshot of the structure from the time when the universe became transparent can be seen in the cosmic microwave background (CMB). For a long time mainly the power spectrum of the CMB temperature fluctuations has been used to obtain observational constraints, especially on deviations from scale-invariance and pure adiabacity. Non-Gaussian perturbations provide a novel and very promising way to test theoretical predictions. They probe beyond the power spectrum, or two point correlator, since non-Gaussianity involves higher order statistics. The thesis concentrates on the non-Gaussian perturbations arising in several situations involving two scalar fields, namely, hybrid inflation and various forms of preheating. First we go through some basic concepts -- such as the cosmological inflation, reheating and preheating, and the role of scalar fields during inflation -- which are necessary for the understanding of the research papers. We also review the standard linear cosmological perturbation theory. The second order perturbation theory formalism for two scalar fields is developed. We explain what is meant by non-Gaussian perturbations, and discuss some difficulties in parametrisation and observation. In particular, we concentrate on the nonlinearity parameter. The prospects of observing non-Gaussianity are briefly discussed. We apply the formalism and calculate the evolution of the second order curvature perturbation during hybrid inflation. We estimate the amount of non-Gaussianity in the model and find that there is a possibility for an observational effect. The non-Gaussianity arising in preheating is also studied. We find that the level produced by the simplest model of instant preheating is insignificant, whereas standard preheating with parametric resonance as well as tachyonic preheating are prone to easily saturate and even exceed the observational limits. We also mention other approaches to the study of primordial non-Gaussianities, which differ from the perturbation theory method chosen in the thesis work.

Price Inflation, Unemployment and Devaluations: The Finnish Experience of the 1990s

In this paper I provide some empirical answers to important questions such as the determinants of price inflation and the role of inflation polices. The results indicate that monetary policy is surprisingly impotent as a device for controlling inflation and there is little support that it influences the real variables. The low inflation after the Finnish devaluations in the beginning of 90s is foremost due to a previous imbalance in the labor markets and depressed aggregate demand.