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Optimal Monetary and Fiscal Policy: A Linear Quadratic Approach

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  • Pierpaolo Benigno
  • Michael Woodford

Abstract

We propose an integrated treatment of the problems of optimal monetary and fiscal policy, for an economy in which prices are sticky and the only available sources of government revenue are distorting taxes. Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, we derive targeting rules through which the monetary and fiscal authorities may implement the optimal equilibrium.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9905.

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Date of creation: Aug 2003
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Publication status: published as P. Benigno & M. Woodford, 2003. "Optimal monetary and fiscal policy: a linear-quadratic approach," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
Handle: RePEc:nbr:nberwo:9905

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  1. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 33(3), pages 669-728, August.
  2. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Staff Report, Federal Reserve Bank of Minneapolis 147, Federal Reserve Bank of Minneapolis.
  3. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers, Columbia University, Department of Economics 0405-04, Columbia University, Department of Economics.
  4. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers, Princeton University, Department of Economics, Center for Economic Policy Studies. 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
  5. Correia, Maria Isabel Horta & Nicolini, Juan Pablo & Teles, Pedro, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3730, C.E.P.R. Discussion Papers.
  6. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2942, C.E.P.R. Discussion Papers.
  7. Lars E. O. Svensson & Michael Woodford, 2003. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Working Papers 9747, National Bureau of Economic Research, Inc.
  8. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 825-860, October.
  9. 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.
  10. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  11. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  12. George J. Hall & Stefan Krieger, 2000. "Tax Smoothing Implications of the Federal Debt Paydown," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 253-302.
  13. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers, Stockholm University, Institute for International Economic Studies 646, Stockholm University, Institute for International Economic Studies.
  14. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, American Economic Association, vol. 80(5), pages 1217-30, December.
  15. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 277-316.
  16. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  17. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers, C.V. Starr Center for Applied Economics, New York University 99-13, C.V. Starr Center for Applied Economics, New York University.
  18. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  19. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  20. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  21. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(3), pages 575-607, April.
  22. 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.
  23. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  24. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 2(1), pages 1-53, February.
  25. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(5), pages 940-71, October.
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