FISCAL EXPANSION, MONETARY-POLICY, INTEREST-RATE RISK PREMIA, AND WAGE REACTIONS

We examine the macroeconomic implications of fiscal policy in a small open economy, with emphasis on the interactions between fiscal, moneta ry and labour market policies. The paper uses the NBNZ-DEMONZ macroeco nometric model. Novel features of the model are that it includes an en dogenous,interest rate risk premium (IRRP), and forward-looking moneta ry and fiscal policy reaction functions which capture the essence of N ew Zealand's Reserve Bank and Fiscal Responsibility Acts. The most imp ortant empirical result is that the postulated IRRP, proxying financia l market mechanisms, can contribute at least as much as the monetary p olicy reaction function to maintaining price stability. Also of signif icance are that an income tax cuts package shows more damped real GDP and underlying inflation paths than does an expenditure increases equi valent; and that the inflationary and real sector impacts of a persona l income tax cut package depend heavily on how the cut is 'shared' bet ween firms and workers. The nature and interdependence of monetary and fiscal policies and labour market conditions are therefore crucial to the macroeconomic outcomes. (C) 1998 Elsevier Science B.V. All rights reserved. JEL classifications: C53, E47, E62, E63.