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Optimal Fiscal and Monetary Policy Without Commitment

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  • Stefan Niemann

    ()

  • Paul Pichler

    ()

  • Gerhard Sorger

    ()

Abstract

This paper studies optimal fiscal and monetary policy in a stochastic economy with imperfectly competitive product markets and a discretionary government. We find that, in the flexible price economy, optimal time-consistent policy implements the Friedman rule independently of the degree of imperfect competition. This result is in contrast to the Ramsey literature, where the Friedman rule emerges as the optimal policy only if markets are perfectly competitive. Second, once nominal rigidities are introduced, the Friedman rule ceases to be optimal, inflation rates are low and stable, and tax rates are relatively volatile. Finally, optimal time-consistent policy under sticky prices does not generate the near-random walk behavior of taxes and real debt that can be observed under optimal policy in the Ramsey problem. A common reason for these results is that the discretionary government, in an effort to asymptotically eliminate its time-consistency problem, accumulates a large net asset position such that it can finance its expenditures via the associated interest earnings.

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Bibliographic Info

Paper provided by University of Essex, Department of Economics in its series Economics Discussion Papers with number 654.

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Date of creation: 16 Jun 2008
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Handle: RePEc:esx:essedp:654

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2003. "Optimal Fiscal and Monetary Policy Under Imperfect Competition," NBER Working Papers 10149, National Bureau of Economic Research, Inc.
  2. Ramon Marimon & Javier Díaz-Giménez & Giorgia Giovannetti & Pedro Teles, 2007. "Nominal Debt as a Burden on Monetary Policy," NBER Working Papers 13677, National Bureau of Economic Research, Inc.
  3. repec:bla:restud:v:75:y:2008:i:3:p:789-808 is not listed on IDEAS
  4. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  5. Chari, V. V. & Christiano, Lawrence J. & Kehoe, Patrick J., 1996. "Optimality of the Friedman rule in economies with distorting taxes," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 203-223, April.
  6. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  7. Klein Paul & Quadrini Vincenzo & Rios-Rull Jose-Victor, 2005. "Optimal Time-Consistent Taxation with International Mobility Of Capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-36, June.
  8. Salvador Ortigueira & Joana Pereira, 2007. "Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets," Economics Working Papers ECO2007/41, European University Institute.
  9. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
  10. Paul Klein & Per Krusell & José-V�ctor R�os-Rull, 2008. "Time-Consistent Public Policy," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 789-808.
  11. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
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Cited by:
  1. Niemann, Stefan & Pichler, Paul, 2011. "Optimal fiscal and monetary policies in the face of rare disasters," European Economic Review, Elsevier, vol. 55(1), pages 75-92, January.
  2. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 234-247.
  3. Richard Dennis, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," Working Papers 2013_15, Business School - Economics, University of Glasgow.
  4. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2009. "Inflation dynamics under optimal discretionary fiscal and monetary policies," Economics Discussion Papers 681, University of Essex, Department of Economics.

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