Interest Rate Liberalization and Fiscal Policy in China: A New Keynesian DSGE Model

By building a new Keynesian dynamic stochastic general equilibrium (DSGE) model, we analyze the effect of interest rate liberalization on fiscal policy. First, we find that when the interest rate increases, technology shocks, monetary policy shocks, and fiscal policy shocks can effectively stabilize economic fluctuations. Second, when the interest rate rises, fiscal policy enhances the positive effect on output first, with decreasing the negative effect on output later. Third, fiscal policy increases the original crowding-out effect on consumption and investment. However, this increase in the crowding-out effect does not restrain the positive effect of fiscal policy on output, which benefits from interest rate liberalization.