Advanced Search
MyIDEAS: Login to save this paper or follow this series

Optimal Simple and Implementable Monetary and Fiscal Rules

Contents:

Author Info

  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

The goal of this paper is to compute optimal monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple policy rules whereby the nominal interest rate is set as a function of output and inflation, and taxes are set as a function of total government liabilities. We require policy to be implementable in the sense that it guarantees uniqueness of equilibrium. We do away with a number of empirically unrealistic assumptions typically maintained in the related literature that are used to justify the computation of welfare using linear methods. Instead, we implement a second-order accurate solution to the model. Our main findings are: First, the size of the inflation coefficient in the interest-rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response of the nominal interest rate to output can lead to significant welfare losses. Third, the optimal fiscal policy is passive. However, the welfare losses associated with the adoption of an active fiscal stance are negligible.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w10253.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10253.

as in new window
Length:
Date of creation: Jan 2004
Date of revision:
Publication status: published as Schmitt-Grohe, Stephanie and Martin Uribe. "Optimal Simple and Implementable Monetary and Fiscal Rules." Journal of Monetary Economics 54, 6 (September 2007): 1702-25.
Handle: RePEc:nbr:nberwo:10253

Note: ME
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers, Rutgers University, Department of Economics 200105, Rutgers University, Department of Economics.
  2. Lutz Weinke & Tommy Sveen, 2003. "Inflation and output dynamics with firm-owned capital," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 702, Department of Economics and Business, Universitat Pompeu Fabra.
  3. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 25(1), pages 11-44, January.
  4. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2000. "Optimal monetary policy," Working Paper, Federal Reserve Bank of Richmond 00-10, Federal Reserve Bank of Richmond.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper, Federal Reserve Bank of Cleveland 0107, Federal Reserve Bank of Cleveland.
  6. Christopher A. Sims & Jinill Kim & Sunghyun Kim, 2004. "Calculating and Using Second Order Accurate Solution of Discrete Time Dynamic Equilibrium Models," Econometric Society 2004 North American Winter Meetings, Econometric Society 411, Econometric Society.
  7. Julio J. Rotemberg & Michael Woodford, 1989. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," NBER Working Papers, National Bureau of Economic Research, Inc 3206, National Bureau of Economic Research, Inc.
  8. Noah Williams & Andrew Levin & Alexei Onatski, 2005. "Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models," Computing in Economics and Finance 2005, Society for Computational Economics 478, Society for Computational Economics.
  9. Charles T. Carlstrom & Timothy S. Fuerst, 2003. "Investment and interest rate policy: a discrete time analysis," Working Paper, Federal Reserve Bank of Cleveland 0320, Federal Reserve Bank of Cleveland.
  10. Sbordone, A.M., 1998. "Prices and Unit Labor Costs: a New Test of Price Stickiness," Papers, Stockholm - International Economic Studies 653, Stockholm - International Economic Studies.
  11. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 37(4), pages 1661-1707, December.
  12. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Simple and Implementable Monetary and Fiscal Rules: Expanded Version," NBER Working Papers, National Bureau of Economic Research, Inc 12402, National Bureau of Economic Research, Inc.
  13. Schmitt-Grohé, Stephanie & Uribe, Martín, 2006. "Optimal fiscal and monetary policy in a medium-scale macroeconomic model," Working Paper Series, European Central Bank 0612, European Central Bank.
  14. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 341, Department of Economics and Business, Universitat Pompeu Fabra.
  15. David Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2004. "Firm-specific capital, nominal rigidities and the business cycle," Working Paper Series, Federal Reserve Bank of Chicago WP-05-01, Federal Reserve Bank of Chicago.
  16. Favero, Carlo A & Monacelli, Tommaso, 2003. "Monetary-Fiscal Mix and Inflation Performance: Evidence from the US," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3887, C.E.P.R. Discussion Papers.
  17. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  18. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, Oxford University Press, vol. 70(4), pages 743-764.
  19. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4334, C.E.P.R. Discussion Papers.
  20. Jinill Kim & Sunghyun Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and Using Second Order Accurate Solutions of Discrete Time," Levine's Bibliography, UCLA Department of Economics 666156000000000284, UCLA Department of Economics.
  21. Mulligan, Casey B, 1997. "Scale Economies, the Value of Time, and the Demand for Money: Longitudinal Evidence from Firms," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(5), pages 1061-79, October.
  22. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers, National Bureau of Economic Research, Inc 0282, National Bureau of Economic Research, Inc.
  23. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, National Bureau of Economic Research, Inc, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  24. Argia M. Sbordone & Timothy Cogley, 2004. "A Search for a Structural Phillips Curve," Computing in Economics and Finance 2004, Society for Computational Economics 291, Society for Computational Economics.
  25. Stephanie Schmitt-Grohe & Martin Uribe, 1997. "Price level determinacy and monetary policy under a balanced-budget requirement," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1997-17, Board of Governors of the Federal Reserve System (U.S.).
  26. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy under Imperfect Competition," Departmental Working Papers, Rutgers University, Department of Economics 200101, Rutgers University, Department of Economics.
  27. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(2), pages 249-83, April.
  28. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1998. "Monetary Policy and Multiple Equilibria," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-02, C.V. Starr Center for Applied Economics, New York University.
  29. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3346, C.E.P.R. Discussion Papers.
  30. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers, Rutgers University, Department of Economics 199925, Rutgers University, Department of Economics.
  31. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Stabilization policy and the costs of dollarization," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 482-517.
  32. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, Oxford University Press, vol. 72(3), pages 707-734.
  33. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 47(1), pages 83-108, December.
  34. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 37(2-3), pages 345-370, April.
  35. Hicks, J. R., 1975. "Value and Capital: An Inquiry into some Fundamental Principles of Economic Theory," OUP Catalogue, Oxford University Press, Oxford University Press, edition 2, number 9780198282693, October.
  36. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, Elsevier, vol. 98(1), pages 85-113, May.
  37. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
  38. Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeonomic Model," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5424, C.E.P.R. Discussion Papers.
  39. Robert Kollmann, 2004. "Welfare Maximizing Monetary and Fiscal Policy Rules," Computing in Economics and Finance 2004, Society for Computational Economics 102, Society for Computational Economics.
  40. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 195-232.
  41. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  42. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 27(1), pages 129-147, February.
  43. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices, Review of Economic Dynamics 09-191, Review of Economic Dynamics.
  44. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:10253. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.