Three Essays on Fiscal and Monetary Policy

This dissertation studies the effects of fiscal and monetary policy on the economy through both theoretical and empirical approaches. It is divided into three chapters. Chapter 1 explores the role of fiscal policy in driving business cycle fluctuations in the presence of financial frictions through a dynamic stochastic general equilibrium (DSGE) model. Utilizing Bayesian estimation methods, I analyze the dynamics of economic variables under a realistic specification of spending and taxation policy. In addition, I conduct a counterfactual exercise by comparing the impulse response functions (IRFs) from the models with and without financial frictions, and I find that financial frictions amplify the effects of fiscal shocks on output and inflation. This study provides new insight into understanding the role of financial frictions in affecting the transmission mechanism of fiscal policy. I investigate the role of fiscal policy in driving business cycle fluctuations in the presence of financial frictions through a Structural Vector Autoregression (SVAR) model in chapter 2. I explore the effects of four fiscal policy shocks: government spending shocks, government transfer shocks, individual labor income tax rate shocks, and consumption tax rate shocks on the economy. The model has nine variables including GDP, consumption, investment, inflation, hours worked, federal funds rate, government debt, credit spread, and one fiscal variable. I utilize the U.S. quarterly data from 1986Q1 to 2023Q2 to conduct this empirical analysis, as well as several robustness checks. In addition, this study indicates that financial frictions, measured by the credit spread, can play a critical role in transmitting the effects of fiscal policy shocks on macroeconomic variables. In chapter 3, I examine monetary policy and business cycles in China utilizing a New Keynesian dynamic stochastic general equilibrium (DSGE) model. Based on the model calibrated to Chinese data from 2000Q1 to 2022Q1, the simulated impulse response functions (IRFs) indicate that a one standard deviation monetary policy shock increases output for approximately six quarters and inflation for about ten quarters. Additionally, a one standard deviation technology shock increases both output and consumption for around ten quarters. This study provides new evidence on the effects of China’s monetary policy and technological progress on output and inflation.