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Inflation dynamics under optimal discretionary fiscal and monetary policies

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  • Stefan Niemann

    ()

  • Paul Pichler

    ()

  • Gerhard Sorger

    ()

Abstract

We examine the dynamic properties of inflation in a model of optimal discretionary fiscal and monetary policies. The lack of commitment and the presence of nominally risk-free debt provide the government with an incentive to implement policies which induce positive and persistent inflation rates. We show that this property obtains already in an environment with flexible prices and perfectly competitive product markets. Introducing nominal rigidities and imperfect competition has no qualitative but important quantitative implications. In particular, with a modest degree of price stickiness our model generates inflation dynamics very similar to those experienced in the U.S. since the Volcker disinflation of the early 1980s.

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Bibliographic Info

Paper provided by University of Essex, Department of Economics in its series Economics Discussion Papers with number 681.

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Date of creation: 17 Dec 2009
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Handle: RePEc:esx:essedp:681

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References

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  1. Mark Bils & Pete Klenow & Benjamin Malin, 2009. "Reset Price Inflation and the Impact of Monetary Policy Shocks," Discussion Papers 08-041, Stanford Institute for Economic Policy Research.
  2. Javier Díaz-Giménez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2004. "Nominal debt as a burden on monetary policy," Working Paper Series WP-04-10, Federal Reserve Bank of Chicago.
  3. Marimon, Ramon & Scott, Andrew (ed.), 1999. "Computational Methods for the Study of Dynamic Economies," OUP Catalogue, Oxford University Press, number 9780198294979.
  4. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 234-247.
  5. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  6. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
  7. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2008. "Optimal Fiscal and Monetary Policy Without Commitment," Economics Discussion Papers 654, University of Essex, Department of Economics.
  8. John C. Driscoll & Steinar Holden, 2003. "Inflation persistence and relative contracting," Finance and Economics Discussion Series 2003-29, Board of Governors of the Federal Reserve System (U.S.).
  9. Pau Rabanal & Juan F. Rubio-Ramirez, 2003. "Inflation persistence: how much can we explain?," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 43-55.
  10. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  11. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
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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. Fernando Martin, 2012. "Debt, Inflation and Central Bank Independence," 2012 Meeting Papers 1019, Society for Economic Dynamics.
  3. Fernando M. Martin, 2011. "Government policy in monetary economies," Working Papers 2011-026, Federal Reserve Bank of St. Louis.
  4. Stefan Niemann & Paul Pichler & Gerhard Sorger, 2010. "Central bank independence and the monetary instrument problem," Economics Discussion Papers 687, University of Essex, Department of Economics.
  5. Dennis, Richard, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," SIRE Discussion Papers 2013-79, Scottish Institute for Research in Economics (SIRE).

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