Modern macroeconomics literature emphasises both the short run
and long run objectives of fiscal policy [Romer (2006)]. In the short
run it can be used to counter output cyclicality and/or stabilise
volatility in macro variables, which is descriptively same as of effects
of the short run monetary policy. Further for the long-run, fiscal
policy can also affect both the demand and supply side of the economy.
But in most traditional analyses it is assumed that fiscal policy would
adjust to ensure the intertemporal budget constraint to be satisfied,
while monetary policy is free to adjust its instruments [‘Ricardian
Regime’ by Sargent (1982)] such as stock of money supply or the nominal
interest rate [Walsh (2003)]. The debt financing methods, expenditure
and tax powers of fiscal authorities i.e. the fiscal policy has also
been seen as to affect both the supply and demand side of the economy.
As noted by Baxter and King (1993), the initial Real Business Cycle
models had only the supply side effects of the fiscal policy, where
these were transmitted through the wealth effect and labourleisure
choices of the household. Recently also New-Keynesian type models with
micro-foundations and sticky prices argue that still through the supply
side fiscal policy management could be accorded for stabilisation
[Linnemann and Schabert (2003)]. The demand side effects of the fiscal
policy could also be found only with more imperfections such as ‘Rule of
Thumb’ consumers or those with liquidity constraints, which lead to
exclusion of Ricardian equivalence [Gali, et al. (2005)]. But all that
depends on the structure of the economy, as Blanchard and Perotti (2002)
stated: