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Fiscal Policy in the New Neoclassical Synthesis

We analytically derive the cyclical effects of fiscal policy shocks in a New Neoclassical Synthesis model. Price stickiness has the consequence that a rise in government demand affects labor demand, while at the same time the usual wealth effect boosts labor supply. The strength of the demand effect depends on the response of the real interest rate governed by the monetary policy regime. When the central bank controls money growth, fiscal expansions are deflationary and might even be contractionary, whereas output, wages, and, inflation can increase when the rise in the real interest rate is dampened by an interest rate rule. However, price stickiness alone is not sufficient to explain a rise in consumption as predicted by Keynesian theory.