| This thesis consists of three essays which examine the response of fiscal policy to monetary policy shocks, and the implications of this response for other macroeconomic variables of interest.;The first essay examines the optimal dynamic response of government expenditure, public debt, and taxes to an unanticipated monetary policy decision made by an independent central bank. I develop an extension of the Lucas-Fuerst liquidity effects model which includes an endogenous government agent, and in which the liquidity effect initially dominates the anticipated inflation effect. In the period of a positive monetary shock, the optimal response is to increase public debt and government expenditure, to take advantage of lower interest rates. In subsequent periods, as anticipated inflation effects become dominant, debt and expenditure fall as the interest rate rises. Taxes fall as the anticipated inflation effect becomes dominant, in order to minimise the negative impact of higher prices on household consumption. This outlines an additional propagation mechanism, where monetary shocks affect fiscal policy, which then affects output and employment. I also show that Christiano and Eichenbaum's (1992a) dominant liquidity effect is not robust to the introduction of a utility maximising government agent into the credit market.;Recent research has shown that models which incorporate monopolistic competition, sticky prices, and pricing-to-market are able to generate predictions about the international monetary transmission mechanism which are consistent with empirical evidence. In the second essay, I introduce a government sector into an open economy model with these features, and examine the optimal response of fiscal policy to monetary policy shocks, shocks to world inflation, and shocks to world real interest rates. I find that assuming fixed tax rates for government increases the scale and persistence of the liquidity effect.;The third essay uses the vector autoregression methods pioneered by Sims (1980) to examine the dynamic responses of government expenditure, real total revenue, real tax revenue, and real outstanding public debt, to monetary policy shocks. This is done for both United States and Canadian data. I examine the magnitude and direction of the responses, as well as their statistical significance. |
