Optimal combination of fiscal and monetary policy in China

This paper constructs a nonstationary DSGE model with money supply mechanism in a new Keynesian framework. Based on the Bayesian estimation of model´s parameters and policy loss function, we analyze the optimal combination issues of fiscal and monetary policy. The results indicate that in terms of policy loss function, the optimal combination policy would dominate separate optimal fiscal or optimal monetary policy. Moreover, in the optimal combination, fiscal rules should be countercyclical and to stabilize government liabilities, and on the other hand, monetary policy should be procyclical and to stabilize inflation.