Macroeconomic equilibrium and welfare under simple monetary and switching fiscal policy rules

Using a standard forward-looking New Keynesian model, this paper investigates rational expectation equilibrium determinacy and macroeconomic performance of simple monetary policy rules under exogenous versus endogenous tax policies when there is tax uncertainty. Under the endogenous tax framework, we found: 1. responding to tax allows monetary policy to have control on the determinacy region, hence higher policy flexibility with respect to the fiscal policy conduct; 2. welfare improvement may come at the expense of cycling. The risk minimizing monetary policy behavior may become problematic since loss function values display huge variations depending on the probabilities given to future tax policy outcomes. (C) 2013 Elsevier B.V. All rights reserved.