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Distortionary Tax Instruments and Implementable Monetary Policy

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  • Zagaglia, Paolo

    ()
    (Dept. of Economics, Stockholm University)

Abstract

I introduce distortionary taxes on consumption, labor and capital income into a New Keynesian model with Calvo pricing and nominal bonds. I study the relation between tax instruments and optimal monetary policy by computing simple rules for monetary and fiscal policy when one tax instrument at a time varies, while the other two are fixed at their steady-state level. The optimal rules maximize the second-order approximation to intertemporal utility. Three results emerge: (a) when prices are sticky, perfect inflation stabilization is optimal independently from the tax instrument adopted; (b) the optimal degree of responsiveness of monetary policy to output varies depending on which tax instrument induces fluctuations in the average tax rate; (c) when prices are flexible, fiscal rules that prescribe unexpected variations in the price level to support debt changes are always welfare-maximizing.

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Bibliographic Info

Paper provided by Stockholm University, Department of Economics in its series Research Papers in Economics with number 2007:5.

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Length: 41 pages
Date of creation: 21 May 2007
Date of revision:
Handle: RePEc:hhs:sunrpe:2007_0005

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Postal: Department of Economics, Stockholm, S-106 91 Stockholm, Sweden
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Web page: http://www.ne.su.se/
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Keywords: Nominal rigidities; distortionary taxation; monetary-policy rules;

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References

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  16. Matthias Paustian, 2003. "Gains from second-order approximations," Bonn Econ Discussion Papers bgse25_2003, University of Bonn, Germany.
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Cited by:
  1. Paolo Zagaglia, 2007. "Operational Fiscal and Monetary Policy with Staggered Wage and Price Dynamics," Finnish Economic Papers, Finnish Economic Association, vol. 20(2), pages 121-138, Autumn.

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