Fiscal expansion, interest rate risk premia, and wage reactions: Some illustrative simulations with NBNZ-DEMONZ

Abstract

The macroeconomic implications of fiscal expansion in a small open economy are examined using the NBNZ-DEMONZ macroeconometric model. The model has been extended to include an endogenous interest rate risk premium (IRRP), and a forward-looking fiscal policy reaction function. An income tax cuts package shows more damped real GDP and underlying inflation paths than does an expenditure increases equivalent; the postulated IRRP proxying financial market mechanisms can contribute at least as much as the monetary policy reaction function to maintaining price stability; the time period over which the fiscal expansion is implemented is vital to outcomes; and the inflationary and real sector impacts of a personal income tax cut package depend heavily on how the cut is 'shared' between firms and workers.