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Jointly Optimal Monetary and Fiscal Policy Rules Under Borrowing Constraints

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  • Michael Kumhof
  • Huixin Bi

Abstract

We study the welfare properties of an economy where both monetary and fiscal policy follow simple rules, and where a subset of agents is borrowing constrained. The optimized fiscal rule is far more aggressive than automatic stabilizers, and stabilizes the income of borrowingconstrained agents, rather than output. The optimized monetary rule features super-inertia and a very low coefficient on inflation, which minimizes real wage volatility. The welfare gains of optimizing the fiscal rule are far larger than the welfare gains of optimizing the monetary rule. The preferred fiscal instruments are government spending and transfers targeted to borrowing-constrained agents.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/286.

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Length: 39
Date of creation: 01 Dec 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/286

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Related research

Keywords: Economic models; External shocks; fiscal policy; tax revenue; monetary policy; inflation; government spending; fiscal instruments; real interest rate; budget constraint; fiscal rule; fiscal instrument; nominal interest rate; fiscal policy rules; tax rates; fiscal policy rule; fiscal surplus; fiscal rules; monetary economics; fiscal stimulus; coefficient on inflation; tax labor; inflation target; tax bases; real rates; lower inflation; tax collection; tax system; taxation; fiscal tools; discretionary fiscal policy; tax systems; rate of inflation; government budget; price level; budget surplus; fiscal policy on consumption; taxes on labor; fiscal deficits; budget balances; tax revenues; real variables; public expenditure; budget deficits; expansionary fiscal; fiscal stance; tax income; government budget constraint; fiscal shocks; macroeconomic analysis; fiscal policies; real interest rates; inflation rate; nominal interest rates; inflation response; government spending multipliers;

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