Abstract
We examine fiscal-monetary interactions in a New-Keynesian model with deep habits, distortionary taxes and a sovereign risk premium for government debt. Deep habits crucially affect the fiscal transmission mechanism in that these lead to a counter-cyclical mark-up, boosting the size of a demand-driven output expansion with important consequences for monetary and fiscal policy.____ ____pard____pardeftab720 ____cf0 We employ Bayesian estimates of the model to compute optimal monetary and fiscal policy first in `normal times' with debt starting at its steady state and then in a crisis period with a much higher initial debt-GDP ratio. Policy is conducted in terms of____ optimal commitment, time consistent and simple Taylor-type rules. Welfare calculations and impulse responses indicate that the ability of the simple rules to closely mimic the Ramsey optimal policy, observed in the literature with optimal monetary policy alone, is still a feature of optimal policy with fiscal instruments, but only with `passive' fiscal policy. For crisis management we find some support for slow consolidation with a more active role for tax increases rather than a decrease in government____ spending.____ ____pard____pardeftab720 ____cf0 "