Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/212320 
Year of Publication: 
2015
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 12/2015
Publisher: 
Bank of Finland, Helsinki
Abstract: 
This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis.
JEL: 
C49
C61
C63
C88
E52
E61
Persistent Identifier of the first edition: 
ISBN: 
978-952-323-054-5
Document Type: 
Working Paper

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