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Optimal Fiscal and Monetary Policy: Equivalence Results

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  • Isabel Horta Correia
  • Juan Pablo Nicolini
  • Pedro Teles

Abstract

In this paper, we analyze the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be financed with distortionary taxes. We show that the sets of (frontier) implementable allocations are the same independently of the degree of price stickiness. Furthermore, the sets of policies that decentralize each allocation are also the same except in the extreme cases of flexible and sticky prices, where the sets are larger but still include that common set of policies. In this sense we establish an irrelevance or equivalence of environments. We also describe the minimal set of instruments, in the different environments, and thus discuss equivalence and neutrality of fiscal and monetary instruments. In particular we show that state contingent debt is not necessary, provided there are both consumption and labor income taxes.

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Bibliographic Info

Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200303.

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Date of creation: 2003
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Handle: RePEc:ptu:wpaper:w200303

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  1. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  2. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  3. Isabel Horta Correia & Juan Pablo Nicolini & Pedro Teles, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," Working Papers, Banco de Portugal, Economics and Research Department w200303, Banco de Portugal, Economics and Research Department.
  4. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Optimal Fiscal and Monetary Policy under Imperfect Competition," CEPR Discussion Papers 2688, C.E.P.R. Discussion Papers.
  5. 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.
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  7. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "A Note on the Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(4), pages 860-889, August.
  8. Fiorella De Fiore & Pedro Teles, 2002. "The optimal mix of taxes on money, consumption and income," Working Paper Series, Federal Reserve Bank of Chicago WP-02-03, Federal Reserve Bank of Chicago.
  9. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  10. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 55-93.
  11. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 699-713, October.
  12. 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.
  13. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
  14. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report, Federal Reserve Bank of Minneapolis 251, Federal Reserve Bank of Minneapolis.
  15. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(2), pages 223-244, October.
  16. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
  17. Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 116(1), pages 82-112, 02.
  18. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  19. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "Price-level and interest-rate targeting in a model with sticky prices," Working Paper 9819, Federal Reserve Bank of Cleveland.
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  21. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, Elsevier, vol. 18(3), pages 277-284, November.
  22. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2005. "The Monetary Transmission Mechanism: is it Relevant for Policy?," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
  23. 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.
  24. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper, Federal Reserve Bank of Richmond 98-05, Federal Reserve Bank of Richmond.
  25. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers 22, Massachusetts Institute of Technology (MIT), Department of Economics.
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  1. Más Política Monetaria No Convencional III: Política Fiscal
    by Jesús Fernández-Villaverde in Nada Es Gratis on 2010-09-14 21:46:59
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