In this lecture I will discusses the optimal policy response to a temporary rise in energy prices, a situation like that caused by the war in Ukraine. The objective is to use a tax cut to avoid the emergence of a wage price spiral, in the presence of the kind of real-wage resistance which has been shown to be empirically important, and yet also to avoid large increases in interest rates. I will use a fully articulated macroeconomic model to show how to prevent such a policy strategy from creating excess demand in the short run, thereby counteracting the anti-inflationary effects of the tax cut, and also prevent Ponzi-game-like fiscal outcomes in the longer term. I will begin by describing the basic architecture of the model which I use, an extension of the Simple Extended New Keynesian (SENK) model set out by Vines and Luk (2025), which, in turn, formalises a simple version of the well-known DSGE models put forward by Christiano Eichenbaum and Evans (2005) and Smets and Wouters (2007). I will then present simulations with the model, comparing what happens to outcomes if the consumption tax is cut, as compared with what happens when it is not, so that monetary policy is the only policy instrument available to manage inflation. The purpose of this exercise is to see what benefit can be obtained by making the consumption tax variable.
About the speaker
David Vines is Professor of Economics, and a Fellow of Balliol College, at the University of Oxford. He is also a Research Fellow of the Centre for Economic Policy Research.
From 2008 to 2012 he was the Research Director of the European Union’s Framework Seven PEGGED Research Program, which analysed Global Economic Governance within Europe. Professor Vines received a BA from Melbourne University in 1971, and subsequently an MA and PhD from Cambridge University. From 1985 to 1992 he was Adam Smith Professor of Political Economy at the University of Glasgow.
His research interests are in macroeconomics, including financial frictions, fiscal and monetary interactions, and financial crisis. His recent books include: The Leaderless Economy: Why the World Economic System Fell Apart and How to Fix It (Princeton University Press, 2013, with Peter Temin); The IMF and its Critics: Reform of Global Financial Architecture (Cambridge University Press, 2004, with Christopher Gilbert) and The Asian Financial Crisis: Causes, Contagion and Consequences (Cambridge University Press, 1999, with Pierre-Richard Agénor, Marcus Miller, and Axel Weber).
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