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Fiscal Policy and Optimal Monetary Rules in a non Ricardian Economy

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  • Jean-Pascal Benassy

    (CEPREMAP)

Abstract

We study in this article how the conduct of fiscal policy interacts with the choice of oprimal monetary rules by a central bank. We consider a non Ricardian model with nondistortionary fiscal policyt, and compare two policy packages, one where fiscal and monetary policy are simultaneously optimized, and one where the monetary policy is optimized under a given fiscal policy. We find a number of results that would not appear in the traditional Ricardian framework: (a) the optimal monetary rule may be activist when fiscal policy is kept constant, whereas it is not when combined with optimal fiscal policy; (b) combining optimally fiscal and monetary policies may lead to far superior outcomes, even when, following Sargent and Wallace (1975), government is allowed to react to much less information. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/S1094-2025(03)00017-6
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 6 (2003)
Issue (Month): 3 (July)
Pages: 498-512

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Handle: RePEc:red:issued:v:6:y:2003:i:3:p:498-512

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Related research

Keywords: Monetary policy rules; fiscal policy; interest rate rules; optimal policy; nominal rigidities.;

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References

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  1. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  2. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  3. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  5. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  6. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 655-679, June.
  7. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  8. Bernardino Ad�o & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 699-713.
  9. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-39, August.
  10. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  11. Andrew B. Abel, 1987. "Optimal Monetary Growth," NBER Working Papers 2136, National Bureau of Economic Research, Inc.
  12. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
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  15. Bernardino Adao, 2000. "Gaps and Triangles," Econometric Society World Congress 2000 Contributed Papers 1904, Econometric Society.
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Cited by:
  1. Marcela Meirelles-Aurelio, 2005. "The performance of monetary and fiscal rules in an open economy with imperfect capital mobility," Research Working Paper RWP 05-01, Federal Reserve Bank of Kansas City.
  2. Xavier Ragot, 2005. "A theory of low inflation in a non Ricardian economy with credit constraints," PSE Working Papers halshs-00590788, HAL.
  3. Javier Andrés & Rafael Doménech & Campbell Leith, 2006. "Fiscal Policy, Macroeconomic Stability And Finite Horizons," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(1), pages 72-89, 02.

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